Should I operate as a sole trader or limited company?

Aug 20, 2021 | business advice, tax advice

People who run businesses often come to us with a specific question: would I be better off running my business as a sole trader, or as a limited company?

Both options come with pros and cons, from lower tax on the one hand to more legal responsibilities on the other – and there’s no one-size-fits-all answer.

To work it out for each client, we usually have to talk around it a bit – not for hours, don’t worry, we’re all busy! – and nail some basic facts.

Speaking of basic facts, let’s quickly run through the key differences between these two types of business structure.

What’s the difference between a sole trader and a limited company?

A sole trader is exactly what it sounds like: an individual running a business, solely responsible for its success or failure.

You are the business. The business is you. What the business earns, you earn. What it owns, you own. It’s the simplest structure there is.

A limited company, on the other hand, is its own legal entity. You can own the company, and be the sole company director, but you’re still separate from it in legal terms.

Some of the other distinctions you might think apply, don’t. For example, you can be a sole trader with employees, or have a limited company with none. And though limited companies are often bigger, they don’t have to be.

So why choose one over the other?

Pros and cons of sole trader status

The simplicity and ease of administration is a big bonus for sole traders.

There’s less paperwork, fewer registrations and returns, and you only have to complete one tax return – for personal income tax self-assessment.

On the downside, if the business gets into trouble, your assets could be on the line. Your house and car, for example, could be seized to pay your creditors.

And if the business goes bust, you could face personal bankruptcy, with all the restrictions that brings.

On top of all that, what gets most people thinking about setting up a limited company are the potential tax benefits: as a sole trader, you pay personal income tax on your business profits, which can amount to a fair old whack if you’re doing well.

Limited company pros and cons

Reading the above, a limited company might sound like the obvious choice.

First, there’s that clue in the phrase itself: ‘limited’. It’s not the company that’s limited, in fact, but your liability for it.

In other words, if you run a limited company and it can’t pay its debts, you, as a director, won’t be personally liable. There’s essentially a protective barrier between you and the business.

You’ll also benefit from the opportunity to potentially pay less tax.

Directors are employed by the company – a bit weird to effectively be your own employee, but that’s how it goes.

They pay income tax and NICs on the salary they choose to pay themselves. If that salary is kept below £12,570, the personal allowance threshold, you might not have to pay income tax at all.

Usually, company directors will make up their income to a reasonable amount with a mix of dividends and pension contributions, all carefully calculated by us for maximum tax efficiency.

Then, the company pays corporation tax on its profits at a rate of 19% in 2021/22 – lower than the equivalent personal income tax rate for most businesses.

But of course there are downsides to consider. For one thing, limited companies come with a ton of statutory obligations.

For instance, you’ve got to register with Companies House and HMRC, submit a corporation tax return as well as a personal tax return – and put all your personal information (name, address, date of birth) online for the world to see. You’ll also need a dedicated business bank account.

A straight answer

Obviously, it’s complicated, but I always say I’ll do my best to give a straight answer, so here goes.

If your business is turning over more than about £30,000 a year, you should consider setting up a limited company. That’s when the costs of administration generally start to get cancelled out by the tax savings.

Get in touch to run the numbers for your business, or if you want help administering your limited company.

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