Sole trader or limited company? The pros and cons

Partnerships suit certain types of businesses, and sole traders can work together in a general partnership. However, most choose to be either a lone sole trader or a limited company. 

 

According to the latest government figures there are over 5.5million privately owned businesses of which 99% employ less than 50 people. That’s a decrease of 1.5% compared with the previous year. Of these 3.1million are sole traders (56%), 2.1million are trading companies (37%) and 353,000 are ordinary partnerships (6%). 

 

A sole trader. As a sole trader you are a self-employed person and the sole owner of your business. This is the simplest business structure. For tax purposes you register as a sole trader on the government’s website. 

 

As a sole trader you pay yourself, rather than receiving a salary from an employer, so you’ll need to complete an annual self-assessment tax (SAT) return. You’ll pay your personal income tax at 20%, 40% or 45%, depending on your earnings. 

 

You can keep all the profits after tax to pay yourself or to reinvest in your business. The details of your business are private and aren’t published on the Companies House website. 

 

The most important consideration is your personal liability for your business activities, including debts and losses. There’s no legal difference between you and your business so your liability is unlimited. If you have business debts, for example, your personal assets could be used to repay them. 

 

Raising finance is sometimes difficult for sole traders because banks and investors generally prefer the legal structure of limited companies. Sometimes larger clients also prefer to do business with a limited company rather than individuals. 

 

A limited company. When you set up a limited company it has its own legal identity which is separate from its shareholders, managers and directors. Your company is registered at Companies House, your accounts are public and the business pays Corporation Tax on profits. Just one person can run a company as the only shareholder and director. You might wonder why someone would do that, but there are some good reasons. 

 

Because the company is legally separate from its owners, there’s more personal protection if there are business debts. You can also protect your reputation because once you’ve registered your company name nobody else can use it. 

 

Your company pays corporation tax on a sliding scale of 19% to 25% depending on profits. However, that’s less than the 40% higher rate income tax you pay on earnings over £50,270 as a sole trader. You can also offset company profits against a wider range of allowances and tax-deductible costs. 

 

As an employee of the company, you are paid a salary through payroll. Many directors only pay themselves their personal tax allowance (£12,570) to reduce the tax and National Insurance contributions they pay. 

 

If your business makes a profit after tax you can also receive dividends. The first £1,000 of dividends are tax free this year, but this goes down to £500 from April next year. Above this you will pay tax at 8.75% as a basic rate taxpayer. This goes up to 33.75% as a higher rate taxpayer and 39.35% as an additional rate taxpayer. 

 

Other shareholders in your business can also receive dividends after your corporation tax is paid, but only up to the amount of profits available. This can be helpful if other shareholders haven’t used all their tax-free or basic rate allowances for the year. 

 

However, limited company directors have more responsibilities. This adds to the costs and time it takes to administer your business. You will need to submit a company tax return each year as well as annual accounts and your own self-assessment tax return. 

 

Your decision might depend on your earnings as a sole trader. You could find it’s more tax efficient for your business to operate as limited company. 

 

Your choice can affect more than profits and paperwork, so it’s a good idea to ask for some professional advice. Things like your business insurance could be affected, for example. The best business structure for you will also depend on your personal circumstances. 

We’ll be happy to discuss these options with you and provide figures to show you how each will affect your business, so please get in touch.