Are you better off as a Limited Company or a Sole Trader

When starting a business, or indeed as an established business, choosing the most suitable legal structure for your business is an important thing to consider. Two popular options are operating as a sole trader or forming a limited company. Each of these options comes with its own set of pros and cons, especially when it comes to tax.

Sole trader

A sole trader is the simplest form of business. You don’t need a separate bank account (though we’d always advise it) and you don’t need to register your business with Companies House. There is very little admin involved and every penny you earn goes directly to you.

When it comes to paying tax, everything you generate through your business is yours, so you pay income tax and national insurance contributions through self assessment. Sole Traders are still required to register for VAT once you cross the £90,000 turnover threshold but this is the case for any business. Generally speaking, your tax affairs will be more straightforward.

Straightforward, however, is not the same as efficient. You could be paying more tax overall as a sole trader, especially once you are earning over £40,000 per year. That can then have additional disadvantages the more successful the business becomes – you may, for example, find you are subject to the High Income Child Benefit Charge. Limited companies have certain tax advantages, and you can choose when and how to pay yourself, reducing the overall tax bill.

Also, as a sole trader you are trading with unlimited liability. There is no legal distinction between the business and you as an owner. This means you are personally liable for any debts or legal claims against the business and means that your personal assets could be at risk should something go wrong.

Limited company

If you choose, instead, to form a limited company, you are creating a separate legal entity to yourself. This limits your overall business liability to the value of the company and its assets. This can provide a layer of protection for your personal assets.

You are also able to benefit from more tax-efficient structures. For example, as an owner, you can pay yourself through a combination of salary and dividends, which may result in lower overall tax liabilities compared to sole traders, who pay income tax and national insurance on all profits. When things are going well, you can also choose to defer paying yourself until the next tax year, which could mean you can keep your income within the basic rate tax band.

That said, limited companies are subject to more regulatory requirements and administrative tasks. This includes filing annual accounts, maintaining company records, and complying with legal obligations set out by Companies House.

And, while limited companies can enjoy tax advantages, navigating all the rules that relate to companies can be complex. There is usually more work to do when it comes to withdrawing money from the company, for instance you may need to set up and run a payroll to draw a salary, or to document dividend payments.

In conclusion, deciding whether to operate as a sole trader or a limited company involves careful consideration of various factors, including the tax implications. Sole traders benefit from simplicity but face unlimited liability and potential tax disadvantages. On the other hand, limited companies offer limited liability and potential tax efficiency but come with a greater administrative burden and complexity.

If you are considering which of these options is best for you and would like to know more about what is involved or want to know how the tax costs of being a sole trader or a limited company compare, please feel free to contact us. We have helped many businesses reach a decision on their legal structure and would be happy to help you!

Fiona Grant-Jones

As a Management Accountant, I have a proactive focus on the future. I enjoy working with business owners to improve performance through management accounting and forecasting techniques. My knowledge of Tax and Tax planning has supported me in offering a more complete service to our clients. My interests span from the ones that my mother approves of, such as needlecraft and papercraft to the ones she is not so keen on such as scuba diving and skiing!

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