Sole Trader or Limited Company: Which Should You Choose for Your Business?

Author: Russell Smith
October 17, 2018

Starting your own business involves a great deal of planning and consideration. One of the most important decisions you’ll make in your business is how to register it. We look at the benefits and drawbacks of setting up as either a sole trader or limited company, so that you can make the right choice.

Setting up a business is an exciting time, and you’re probably looking forward to getting started and working with clients and customers. However, there’s one little thing you should also be thinking about: tax. And in order to pay the taxman, you need to register your business.

It may not be everyone’s favourite part of being an entrepreneur, but it’s incredibly important — and it can also be quite complex. Should you set up as a sole trader or limited company? In this comprehensive post, we show you how to determine which model is the best fit for your business.

Sole Trader or Limited Company: What Do They Mean?

There’s no escaping it: when you set up your own business, you become responsible for paying your own taxes. You’re probably used to your tax contributions being taken automatically from your salary, as is the norm when you are employed by a company to do a certain job. In self-employment, things work a little differently, and you’ll have to tell HMRC about your business plans (whether you want to be a sole trader or the director of a limited company) and earnings so that it can collect the correct amount of tax from you.

When making the decision whether to register as a sole trader or a limited company, there are a number of considerations you should take into account to make sure that you choose the route that’s going to best benefit your business. First though, it’s important to understand exactly what these routes look like.

Operating as a sole trader means that your business is owned entirely by you. You possess complete control over how you spend your profits, who you hire (if anyone) and any liabilities (such as debt).

A limited company is typically made up of multiple employees (those who work for the business), directors (those who make the major decisions in the business), and shareholders (who hold a stake in the business and are entitled to dividends — a share of the business’ profit). However, this isn’t always the case, as it is possible to run a limited company completely independently.

When researching your options, you may come across the terms limited company status (LTD — what we’re discussing) and public limited company (PLC). While these may sound similar, and in many ways they are (since they operate in the same way), one will likely be more suitable for you than the other. To set up a public limited company requires meeting a set criteria, which includes having multiple shareholders and directors and having a brand value of at least £50,000 — which probably isn’t yet a reality in your new business!

The Differences Between Sole Trader and Limited Company Status

Choosing between establishing a sole trader business and a limited company may seem like a complicated decision — there are tax benefits of going down the latter route, but if privacy and accounting complexity are big concerns, then setting up as a sole trader will be the more attractive option (at least for now). With advantages to both, you may be left with your hands up in the air, not knowing what to do. Let’s look at some of the main considerations that will influence your choice.

Your Current Situation

As an entrepreneur, it’s easy to get caught up in the excitement of making money for yourself and having big, bold ambitions of world domination. It’s important to have these long-term goals and projections of success to keep you motivated and give you a benchmark for measuring success. However, in doing so, you risk making the setup process far more complicated than it needs to be.

Here’s an example:

Many people starting out on their own for the first time often do so on a part-time basis. This allows them to steadily grow their business while having the security of a salary (whether they’re still working full-time or have reduced their hours to dedicate more time to their new venture). In this instance, where the business may not even be fully established, and likely hasn’t reached its full potential, opting to register as a sole trader would be the more sensible option.

For those who are currently still employed, operating a business as a sole trader might be easier to explain than forming a limited company.

Your Market

Market research is a necessary step for any entrepreneur — without it, you won’t know if there’s a demand for your product or service. How thoroughly you research can not only make the difference between whether your business is a success or failure, but it can also be very useful for helping you determine early on how to register your business.

In some industries, it will be impossible for you to succeed as a sole trader, not least because limited status gives potential partners, customers and suppliers confidence and a sense of security in your operation. In fact, many larger businesses will refuse to deal with sole traders, so bear this in mind if you’re targeting — or plan to target — larger businesses.

By taking a look at your existing competition and the gap you want to fill in your market, you can determine whether you would better benefit from setting up a limited company.

Liability and Security

Unlike a limited company, a sole trader business is not recognised as a separate entity by the law, but instead, it becomes an extension of you (including your personal finances and any assets you own, such as your home). Should your business fail and you get in debt as a sole trader, you are still liable for any money owed. In the worst-case scenario, this could mean bankruptcy and even losing your home.

Limited companies, on the other hand, provide much more security. Setting up your business in this way separates it from you legally, placing a degree of protection over you should things go wrong.

When you set up a limited company, you’ll need to register with Companies House and decide whether you want to be the only shareholder in your business, or if you want to add additional shareholders who will receive dividends from your business. This may be a spouse, or children aged over 18 (where dividends could be used to fund university degrees or help them to get settled in their first home, etc). If having a more formal structure in place that also allows you to support yourself and your family is a particular concern, forming a limited company has the advantage.

If you’re considering setting up a limited company, then you probably have your sights set on huge growth — after all, this is where you can reap the largest benefits versus being a sole trader. It’s unlikely that your business will be able to sustain itself if you’re doing all the work, so you may be thinking about employing people to work for you down the line. Establishing a limited company gives you a larger talent pool to choose from, as it can provide more perceived security and gives potential employees peace of mind knowing that their taxes are effectively handled for them.

Tax Savings

One of the main differences between sole trader and limited company businesses is the amount of tax that you will pay. If your business is making a turnover over a certain threshold, you could make significant savings by going limited.

One of the advantages of being a sole trader is that tax is fairly simple. Once a year, you submit a Self-Assessment Tax Return, detailing your earnings. The amount you get taxed on is your turnover, minus any tax-deductible expenses (such as business-related travel). The amount of tax you pay depends entirely on your total taxable income:

For the 2017/18 tax year, the personal allowance sits at £11,500. For the 2018/19 tax year, this has been increased to £11,850. As a sole trader, this is the amount you can earn before you’re entitled to pay any tax.

  • Sole traders earning between £11,851 and £46,450 pay 20% tax on income (Basic Income Tax)
  • Sole traders earning between £45,001 and £150,000 pay 40% tax on income (Higher Income Tax)
  • Sole traders earning anything over £150,000 pay 45% on income (Additional Income Tax).

The above tax brackets are for the tax year beginning in 2018.

In addition to this, sole traders need to pay National Insurance contributions, the amount of which will again depend on your earnings.

For businesses earning anything over £45,000 (and therefore liable to pay at least 40% income tax), setting up as a limited company becomes the more attractive option.

As the director of a limited company, you are effectively treated as an employee of your business, liable to pay a component of Class 1 National Insurance. Your company — acting as your employer — will also pay Class 1 National Insurance. However, you may instead choose to pay yourself a smaller salary and draw the majority of your income from dividends (as a shareholder). This would allow you to be more tax-efficient by reducing the amount of National Insurance you are liable to pay.

As a limited company, you are also liable to pay Corporation Tax on profits. The rate as of the 2018/19 tax year is 19%, though the UK government intends to reduce this to 17% from 2020. When comparing this to the varying amount of tax on income for sole traders, businesses that forecast rapid growth may opt to register as a limited company.

Desire for Privacy

One of the main advantages of being a sole trader is that your financial information is kept private. When you register as a limited company, all the information you’re required to submit both about your business and yourself (as a director) can be accessed publicly by anyone — including your competitors. If you’re concerned about your privacy and don’t want anyone to be able to access your personal information, then it’s worth asking yourself whether registering as a sole trader will be enough for your needs.

Accounting Ease

If you’re concerned about filing your tax returns, the level of paperwork involved will likely be a key factor in your decision to register either as a sole trader or limited company.

There’s no denying it: accounting is far simpler for sole traders than for limited companies. When you register as a sole trader, the process can be done in minutes, as all you need do is inform HMRC that you are now self-employed. In addition to submitting your Self-Assessment Tax Return, you’ll also need to keep any relevant receipts and invoices.

As a limited company, the process is slightly more complicated. You can opt to register with Companies House by post, but the process can be done online for a much lower sum. You’ll also need to register as an employer with HMRC (even if you’ll be working independently — remember, you are seen as an employee of your own business) and for Corporation Tax. This can be done within HMRC’s registration portal.

Once registered, you are responsible for keeping accurate records of any directors, secretaries, and shareholders (though this will be easier if you have appointed yourself for these roles) and submitting these annually in a document called a confirmation statement (previously known as an annual return).

Every year, you will also have to submit the following: annual accounts to both HMRC and Companies House, and a Company Tax Return to HMRC. Your annual accounts must include a balance sheet detailing all assets and liabilities, and a profit and loss statement recording the cash flow in and out of your business over the financial year. Your Company Tax Return will be used to calculate your corporation tax bill.

When it comes to registering as a limited company, we can see that there are more legal obligations to meet (and therefore more paperwork to file) which make things more complex than setting up as a sole trader. This might seem overwhelming, but you may still find that the benefits of becoming a limited company far outweigh the negatives. In this case, a chartered account will be able to help you with the registration process, maintain accurate records and prepare your tax returns.

Ultimately, when deciding whether to set up as a sole trader or limited company, there really is no right or wrong answer — only what best suits your business, both in terms of its current state and your goals for the future.

Need advice on what business model is best for you? Our team of expert chartered accountants are on hand to help you determine how you should register your business. We can also help you with getting set up and preparing for your annual tax returns. Book your free, no-obligation consultation with Russell Smith Accountants today!

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