Sole trader vs limited company: Which is the best option for you?

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How you decide to structure your new business will have a significant impact on how your venture operates and how much tax you’ll need to pay – not to mention how it is perceived by potential clients.

There are three main options: becoming a sole trader, entering a limited liability partnership, or registering a limited company.

Here, we’re going to focus on the pros and cons of the two most popular choices – going it alone as a self-employed entrepreneur i.e. as a sole trader and giving your organisation a separate legal identity to your own as a limited company. 

The advantages and disadvantages of becoming a sole trader

As the name suggests, becoming a sole trader means you’ll work for yourself, by yourself. You won’t have the support of a board of directors – but on the other hand, you’ll be able to run things your way, without having to get other shareholders on board with your decisions. You won’t need to pay to register with Companies House, and all you’ll need to do from a financial perspective is keep an accurate record of your income/expenses and submit your self-assessment tax return every year.

The sole trader approach is often the best fit for freelance professionals, such as photographers, copywriters, designers, journalists, editors, translators, and professional consultants in any field.

Pros:

  • Simple management structure
  • Less paperwork
  • Straightforward tax return process
  • Expenses can be tax-deductible
  • Can still employ staff

Cons:

  • Profits taxed as income, exposing you to the higher rate tax band faster
  • Less tax-efficient overall
  • Not legally separated from your business
  • Liable to clear any debts with your personal assets

The advantages and disadvantages of setting up a limited company instead

Creating a limited company is the easiest way to minimise risk. In our eyes, this is the single most important reason why it’s a better long-term option compared to setting up as a sole trader.

A unique benefit of registering a limited company vs becoming a sole trader is that, as the name suggests, doing so will limit your liability for any debts incurred by your business. This means that if you ever run into financial trouble, you won’t need to use your own hard-earned assets – such as your property – to settle what you owe. Any legal action will also be brought to the company itself, not you as an individual.

Tax savings can also be made when setting up a limited company (although you will need to check with your accountant to find out what this means for you). Limited companies pay corporation tax on net profits (currently 19%), while sole traders will need to pay between 20% and 45% income tax on their gains plus National Insurance contributions.

The limited company route is often ideal for business owners who want to grow quickly; who want to be perceived as more trustworthy and secure by larger clients with more stringent tender processes; or who want to join forces with other entrepreneurs in an environment that’s more structured and protected than limited liability partnership arrangements.

Pros:

  • More secure setup
  • Appeals to banks and funding providers
  • Appeals to larger firms
  • Pay less tax on profits
  • Total income taken via PAYE and dividends
  • Can set up Directors’ Loans
  • Can set up with only one ‘employee’ (you)
  • Can employ staff

Cons:

  • More administrative responsibilities
  • Must register with Companies House
  • Must attend yearly directors’ meetings
  • Must submit corporation tax return every year, as well as personal self-assessment
  • Can be difficult to manage the opinions and expectations of multiple directors and shareholders

Companies MadeSimple makes light work of forming a limited company. We can assist entrepreneurs at every stage of their journey, from those who are setting up a business for the first time to sole traders and contractors who wish to switch to a limited company structure after many years of trading. Contact us for more information on our company formation services or view our registration packages here.

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