Should I trade as a limited company or sole trader?

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    Thinking of starting a business? One of your first decisions as a self-employed person is what business structure to choose. The two most common options are either a sole trader or a limited company. Each path comes with a unique set of advantages and disadvantages, spanning legal, financial, and operational aspects.

    Many business owners start off as sole traders. As earnings grow, transitioning to a limited company offers legal protection and potential tax savings. This strategic move sets the stage for long-term success whilst retaining more of your hard-earned profits for years to come.

    We’ll delve deeper into the pros and cons of both options in this article to help you make an informed decision about the right business structure for your venture.

    Jameco Group is a team of dynamic, proactive accountants who exist to help ambitious small businesses flourish. To arrange a callback to discuss your business ambitions, please get in touch.

    Sole trader or limited company – what’s the difference?

    Although you’re no doubt aware that each business structure comes with different tax requirements and legal responsibilities, let’s start by clarifying what it is to be a sole trader versus a limited company.

    sole trader has personal liability for their business, meaning that they are responsible for repaying business debts, and their personal assets are at risk.

    limited company means that the business is incorporated and becomes a separate legal entity to its owner, offering them limited liability status.

    Income Tax versus Corporation Tax – which is more efficient?

    Both business structures are, of course, required to pay tax.

    Sole traders file a self-assessment tax return annually and are charged Income Tax on their business profits. The rate of tax varies depending on the total income, ranging from 20% to 45%.

    Limited companies complete annual accounts and pay Corporation Tax on their profits each tax year (often at a lower rate compared to a sole trader in the higher rate tax band!). Company directors must also file a self-assessment tax return to declare any dividends and self-employed earnings other than their PAYE salary.

    It’s worth noting Dividend Tax rates are far less than Income Tax and that a director’s salary is also tax deductible for Corporation Tax purposes. That is why we always recommend taking a director’s salary combined with dividends.

    This, along with the ability to defer dividends and carry out advanced tax planning, is why limited companies are generally more tax efficient despite being subject to both Corporation Tax and Income Tax.

    What are the advantages of trading as a sole trader?

    Reduced admin

    Unlike limited companies, sole traders have fewer legal and financial formalities to deal with. They typically don’t need to file as many regulatory documents or hold extensive board meetings.

    Lower overheads

    Sole traders often have fewer expenses related to compliance, such as lower accounting and legal fees. This financial efficiency can be especially beneficial for small businesses or startups looking to maximise their financial resources.

    Fast registration

    In the UK, you can start trading as a sole trader almost immediately after making the decision to do so. All sole traders need to do is register with HMRC as self-employed to get their unique tax reference (UTR) number.

    What are the disadvantages of trading as a sole trader?

    Unlimited liability

    With sole proprietorship, there is no legal distinction between the business and the business owner, which puts them at personal financial risk. It means that if the business incurs debts or legal liabilities, the owner is personally liable for them.

    In other words, your personal assets, including your home and personal finances, are at risk if the business encounters financial or legal issues. A limited company differs in this aspect as it holds its own legal identity.

    Perceived trust

    Operating as a sole trader may create the perception of a less established or less credible business compared to a private limited company. Potential clients or partners might prefer dealing with limited companies because they perceive them as more stable and professional.

    Raising funds

    Unlike limited companies, which can issue shares to attract investors and secure business loans relatively easily, a sole trader will likely find it more difficult to raise funds for business expansion or investment.

    More taxes

    Sole traders pay Income Tax on their company profits. If they are in the higher rate tax band, a sole trader may end up paying a larger share of their earnings in taxes and National Insurance compared to a limited company.

    Transfer of ownership

    Transferring a sole trader business can be complex as it typically involves selling individual assets and client relationships rather than the business as a whole. In contrast, a limited company can have multiple owners and be sold as a whole entity.

    What are the advantages of becoming a limited company?

    Separate legal entity

    A limited company is legally separate from its owners and shareholders. This legal structure means that the owners do not have personal responsibility for business debts (unless they have signed a personal guarantee).

    The company itself can own business assets and enter into contracts in its own name. This “limited liability” provides a significant layer of protection for the company directors, shielding their personal assets from the business’s financial liabilities.

    Tax efficient

    Limited companies and their directors often enjoy tax benefits. The business can save money, as corporate tax rates are often lower than personal tax rates.

    For the company director, it’s easier for them to extract funds from their business via a combination of salary and dividend payments.

    Dividends don’t attract income tax, so provided the salary taken is below the National Insurance threshold, the director will pay less tax overall.

    Credibility

    Becoming a limited company can enhance the credibility and professionalism of a business in the eyes of clients, partners, and investors. A limited company is typically seen as a more established, stable legal structure compared to a sole trader.

    Access to funding

    It’s likely a limited company will have better access to funding sources compared to a sole trader. Banks and investors tend to look at limited companies more favourably as they have a more robust legal structure.

    What are the disadvantages of being a limited company?

    More paperwork

    There are stricter reporting and compliance obligations for a limited company, which typically involves maintaining detailed financial records, filing annual financial statements with Companies House, and adhering to corporate governance regulations.

    This additional administrative burden can be time-consuming for directors, which is why many choose to outsource company secretarial duties to their accountants.

    Startup costs

    Starting and registering a limited company often involves higher initial costs compared to simpler business structures like a sole trader. While the long-term benefits of limited liability and tax efficiency may outweigh these initial costs, it’s something that needs to be budgeted for.

    These additional costs can continue throughout the lifetime of the limited company, e.g. accountant fees for maintaining the company’s compliance.

    Public records

    Records about a limited company’s financial performance, company accounts, ownership structure, and other relevant business details must be submitted to Companies House, which is made public.

    Sole trader businesses only report earnings to HMRC on a self-assessment tax return, which isn’t publicly available.

    At what point should a sole trader become a limited company?

    It’s common for a small business to start up in a sole trader structure due to the simplicity of setup and low admin costs. As things progress and the business makes more money, many sole traders find themselves in an unfavourable tax position, and it becomes in their personal interests to transition to a limited company.

    Some accountants advise business owners to start from day one as a limited company (presumably to increase their fees). But every venture is unique, and it requires careful consideration. At Jameco Group, we give advice strictly on a case-by-case basis and in line with the client’s financial and personal circumstances.

    For example, if you intend to keep your earnings low long term, then trading as a sole trader may be for you. If you expect earnings to grow quickly, we would recommend that legal separation is preferable, so starting a limited company straight away can save you hassle later on. More often than not, when profits reach around £30k, you’ll start to benefit from trading as a limited company if tax efficiency is your goal.

    How can Jameco Group help me?

    If you are unsure about which business structure is most appropriate for your venture, Jameco Group can assist you in making this pivotal decision. We can offer expert guidance and support to help you navigate the complexities of tax, accounting and managing your business finances.

    Our experienced accounting team are on hand to provide personalised advice on whether trading as a sole trader or limited company would be more advantageous. We can offer company formation services, tax planning, and ongoing financial services to ensure your business thrives, no matter which path you choose.

    Please get in touch, we’d love to hear from you.

    Conclusion

    Whether to operate as a sole trader or a limited company depends on various factors such as liability protection, tax implications, and long-term business goals. It’s essential to carefully weigh these considerations and seek professional advice from an accountant to determine the most suitable structure for your circumstances.

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