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It’s a big decision – Limited Company or Sole Trader?

One of the biggest decisions you have when starting a small business is the legal structure used for the business.

It can either be a sole trader or limited company or a partnership. Setting up as a sole trader is the most popular legal structure in the UK, with approximately 3.5 million sole traders in 2019.

Sole traders account for 60% of small businesses in the UK. There were also 1.9 million limited companies, making it the second most popular legal structure.

Below we discuss the main difference between Limited Companies and Sole Traders.

Sole Trader vs. Limited Company – a guide

If you become a sole trader (or if there are two or more people running the business – a partnership), it is very easy to get started. All you need to do is register as self employed with HMRC.
To set up a limited company, you need to choose a company name, and submit incorporation information to Companies House (the registrar of all companies in the UK) before you can start up.
As a limited company director, you have a number of statutory and legal responsibilities, which sole traders don’t share, and you have certain obligations under Company Law.
If you are self employed, your liability if things go wrong with your business, is unlimited. Your personal finances are also alongside your business finances.
On the other hand, a limited liability director’s liability is limited to the amount of equity you have put into the company should things go wrong. The company is a completely separate legal entity from the individual members who own it.
The self employed work out their tax via the annual self assessment process – your business and personal income and expenditure are treated as one.
Limited companies have to pay Corporation Tax on their profits – the rate is currently 19%
As the tax affairs of limited companies are more complex, you will typically pay more in accounting fees than you would as a sole trader or partnership.
Limited companies must prepare annual accounts for submission to HMRC and Companies House. Sole trader accounts are not submitted to HMRC, and are more basic to prepare.
Shareholders draw down income from limited companies via dividends, which is a tax efficient way of receiving income, as National Insurance Contributions are not payable on dividends.
Sole traders and members of a partnership pay Class 2 and Class 4 NICs on their income, together with income tax.
If you are an employee of a limited company, you pay income tax, and Class 1 NICs
As an employer, the limited company is also liable for employers’ Class 1 NICs on the salaries it pays to staff.
Tax planning is more flexible if you are a limited company owner, as you can postpone declaring dividends until a later tax year, in order to use your tax allowances in an efficient way.
The self employed can have pensions, however limited company pension schemes can have more benefits and the contribution limits are higher.
In some industries and professions, it is a requirement that you must operate as a limited company to trade.
It may present a more professional image if you own a company.
There is more administration associated with running a limited company, in terms of accounting and dealing with Companies House.
If you want to sell part of your business to a new partner or investor, the process is cleaner and more attractive to a potential newcomer, if you are incorporated.

So, which is best for you?

The answer is it depends of course. There are many factors to consider, not just the costs or tax position.

Here at F9 Consulting, we are available to have these initial discussions with you and run through the options so you can make the right decision. If this is something you would like help with, please do not hesitate to get in contact with us.

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