Limited company or sole trader?
Many new business owners have to decide whether to set up as either a sole trader or a limited company pretty early on in their business journey.
There are important distinctions between these two business structures, and they both come with their own set of advantages and disadvantages.
Every business is different, and what works for one might be the wrong approach for another. Ultimately, it all comes down to how you want to run your business.
What is a limited company?
A limited company is a structured business legally separate from its owners. This type of business typically has several shareholders and directors, but you can also set one up on your own.
You need a small fee to Companies House for your businesses to start a limited company.
They have stricter rules and regulations compared to sole traders, but may be more profitable, particularly once your business reaches a certain size, because of tax benefits (see below).
Advantages and disadvantages of running a limited company
Because a limited company is its own legal entity, it’s responsible for its own actions if something goes wrong. This means that as a director, you won’t be liable for any company debts, aside from what you personally invested.
Limited companies are generally viewed as more trustworthy than sole traders, so you may attract more clients and better business opportunities.
Limited companies pay corporation tax on their profits, which for the 2023/24 tax year, is likely to remain at 19% – that’s a huge advantage to sole traders, who pay income tax on their profits.
Companies also benefit from a wide array of tax relief schemes, including R&D tax credits, marginal relief and creative industry tax relief for corporation tax.
As a limited company director, you can also increase your tax efficiency by paying yourself a low salary topped up by dividends.
As dividends are taxed at a lower rate than salaries, you’ll be able to save a significant amount of money by trading as a limited company.
However, running a limited company comes with its fair share of challenges. For starters, setting up and running a limited company involves a lot of financial expertise and reporting, and tighter rules on tax.
You will need to prepare annual accounts and pay corporation tax, as well as meet other reporting obligations to HMRC and Companies House, including a director’s report.
When you register with Companies House, your personal details, including your name, address and date of birth, are made available to the general public. If you don’t feel comfortable with this, you may want to consider a different business structure.
All the while, given that there’s a greater need to include shareholders in the business when you run a limited company, you’ll have to accept the thoughts and opinions of your board.
What is a sole trader?
Most new business owners start out as sole traders and run their own business as individuals and are classed as self-employed.
Contrary to running a business as a limited company, if you’re a sole trader, you are the business – there is no legal distinction. You run the business, you take home the profits, and you’re responsible for the losses and debts.
Advantages and disadvantages of being a sole trader
All you need to do to be formally recognised as a sole trader is to register for self-assessment through the HMRC website and pay taxes once a year. This is a lot easier (and cheaper) than registering as a limited company, making it an attractive option for many businesses just starting out.
Unlike with a company, you don’t have to rely on other people to get the job done. Even if you hire other employees, you’ll have full control over any business decisions. Furthermore, if you don’t hire anyone else, 100% of the business’s after-tax profits go to you.
Additionally, while limited company directors have their personal details published by Companies House, sole traders can choose what information they want to disclose.
However, as the sole owner of your business, you’re fully liable if something goes wrong. This means that if your business gets into debt, your personal assets may be put at risk – including your home.
Just like limited companies, sole traders can reduce their tax bills through tricks like reporting all their allowable expenses or making use of the annual investment allowance.
However, limited companies are eligible for a lot more tax relief schemes – again, like R&D tax relief and marginal relief.
Meanwhile, you may miss out on a certain ‘prestige’ some limited companies enjoy. With that, you may miss out on business opportunities and funding as a sole trader.
Making your decision
The right path is not always obvious, and you may want to explore all your options with an expert. There’s a lot of ins and outs, while getting to the right decisions means looking at the data and crunching the numbers.
Our experienced accountants provide great-quality advice to help you make the best decision for you and your business.
Reach out today to set up an appointment.