Sole trader vs limited company

Sole trader vs limited company

Starting your own business is unique and daunting. Working for yourself can be very rewarding but requires work and responsibility. One of the top choices you’ll make when starting a business is whether to operate as a sole trader, partnership, or limited company.

The appropriate business structure will depend on your situation, and there is no one-size-fits-all solution. This article highlights the similarities and differences between a sole trader and a limited company. So, you can decide which option is better for you and helps you understand how both options work.

Sole Trader vs Limited Company: Quick Comparison

Both structures have advantages and disadvantages. The right choice depends on your business goals, profitability, risk exposure, and plans.

Feature	Sole Trader	Limited Company
Legal Status	Owner and business are the same legal entity	Separate legal entity
Personal Liability	Unlimited personal liability	Limited liability
Tax Structure	Income Tax and National Insurance	Corporation Tax and personal taxes where applicable
Administration	Simpler record keeping and reporting	Additional accounting and filing requirements
Privacy	Greater privacy	Certain company information is publicly available
Growth Potential	Suitable for many small businesses	Often preferred for businesses planning growth

Each structure has distinct advantages and disadvantages. The main difference is that a sole trader is personally responsible for all aspects of the business, while a limited company is a separate legal entity that offers limited liability. The best choice depends on your business objectives, profitability, risk tolerance, and long-term plans.

What is a sole trader?

Suppose you decide to run your business as a sole trader. In that case, you are personally responsible for the decisions that affect your business and must file a personal tax return. As a sole trader, you should work hard and delegate your responsibilities. You need to hire staff to make sure you get everything done.

You are personally accountable for any losses or debts incurred by your company because the law considers your business and yourself the same. It also means that any gains made after taxes are yours to retain. Hairdressers, plumbers, and electricians are typical examples of business owners who prefer to operate as sole traders.

What is a limited company?

Suppose you decide to run your business as a limited company. In that case, you will need to create a private limited liability company to run it. Your company will have its own legal identity distinct from yours, and its money will be maintained separately from yours. You will have limited accountability as a director of your limited company for any losses or debts incurred by the company.

What makes a sole trader different from a limited company?

The most fundamental distinction between a sole trader and a limited company is that the owner of a limited company is not personally liable for the business. Instead, the company itself will have unlimited liability. At the same time, sole traders will have unlimited personal liability for their business. Limited liability is a provision that protects companies from personal liability for any debts and losses they incur.

When starting a business as a limited company, shareholders have limited liability for the company, which may entail less personal financial risk.

Sole trader advantages

• Simple to set up and maintain, apart from a yearly self-assessment tax return.
• A sole trader has more privacy than a limited company, whose information is publicly available via Companies House.

Sole trader disadvantages

• Sole traders have more responsibility, meaning there is no legal distinction between them and their business. The owner is at risk of assuming the business incurs obligations.
• As banks and other investors prefer limited companies, raising capital can be difficult for sole traders, and they have limited expansion options.
• Tax rates for sole traders aren’t usually as favourable as those for limited companies. When you reach a certain income level, remaining a sole trader may no longer be as profitable.

Book your free consultation with our sole trader accountant. It’s a chance to get to know you and learn more about the help that’s right for your business.

Limited company advantages

• Unlike a sole trader, a limited company is legally separate from its owner, who has limited liability.
• This implies that your assets aren’t at risk; you’re only at risk of losing the money you put into the company.
• No one can use your company name once you’ve registered it, unlike sole traders who don’t have the same protection.

The principal benefits of a limited company are that it’s not taxed at a higher rate than a sole trader. It also has other benefits. For example, a limited company can claim tax deductions for all costs incurred in running its business. A limited company is also required to pay corporation tax on its profits. This means it can be more profitable to form a limited company than a sole trader.

Overall, a limited company can be more profitable and tax-efficient than a sole trader. It also gives a limited company a more comprehensive range of tax-deductible costs, including business insurance, depreciation, and office equipment.

Limited company disadvantages

• Limited companies have more significant duties. The director’s fiduciary responsibilities define what a limited company director is legally required to perform.
• Going limited might be costly and time-consuming because of these additional duties. You must either handle the extra paperwork yourself or hire an accountant.
• Companies House can access information about your company, which means facts about directors and earnings must be made public. This level of transparency may not be appealing to everyone.

The main downside is that there is no limit on the number of directors on a limited company’s board, which means it can have a large board. This could be an issue if you’re looking to keep your business small.

Book your free consultation to find out how our accountants for a limited company can help with your business tax and accounts.

Which Business Structure Is Right for You?

No single business structure suits everyone.

A sole trader structure may be suitable if:

• You are starting a small business.
• You want a simple business structure.
• Your administrative requirements are minimal.
• You prefer straightforward tax reporting.

A limited company may be more suitable if:

• You want limited liability protection.
• Your business profits are increasing.
• You are planning for future growth.
• You want to enhance business credibility.
• You may introduce shareholders or investors.

Your decision should reflect your unique circumstances and long-term business goals. If you are unsure which structure is right for you, consider seeking advice from a qualified accountant to ensure you make the best choice for your situation.

Limited liability

Limited liability is one of the essential advantages of a limited company structure compared with a sole trader. You can have limited liability in your company. Suppose you want to operate as a sole trader. In that case, you will be entirely responsible for your business and finances because the owner and the business are treated as a single entity.

A limited company, as a business, is a separate entity. To protect your business and your money if it becomes insolvent or goes into bankruptcy, it’s better to incorporate a limited company in the UK.

However, as a sole trader, you should take out as many small-business insurance policies as possible to stay profitable.

As a sole trader, you and your business are the same in the eyes of the law; if you don’t have business insurance policies, you’ll be sued and personally liable for any losses incurred. Another advantage of forming a limited company is that you will not be personally sued because the company is distinct from you as an owner.

Limited company tax

A limited company offers another significant advantage: it makes you liable for fewer business taxes. That’s because a limited company only must pay corporation tax or dividend tax.

Annual accounts

Choosing a limited structure means preparing your annual accounts. This is a legal requirement for the owners of a limited company. Annual accounts are not only essential but also legally required.

You will also need to file a corporation tax return with the Companies House. Sole traders are not required to file accounts and therefore have no legal obligation to do so.

When starting up your limited company, you must seek help from one of our limited company accountants. We will ensure the accounts are up to date and keep them in order.

Perception of limited companies

A limited company is an excellent way to work in the business world because you’ll receive more legal protection and lower your liability. A limited company offers benefits and protections that aren’t available to a sole trader, such as limited liability, shareholder rights, protection against creditors, and more.

Limited liability protects shareholders against business liabilities, such as bankruptcy, fraud, or product liability. Suppose you’re a business, contractor, or client. You’ll be more likely to work with a limited company because people think that a limited company is more professional than a sole trader.

A limited company is a valuable way to establish a business and build a good reputation, making it easier for others to consider working with you. A sole trader business structure is the easiest to set up, so it has become the most popular choice for new businesses. However, limited companies can have some benefits over a sole trader structure.

Make sure you weigh up the pros and cons of the different legal structures available to you before deciding which structure will work best for your circumstances.

Tax differences between a sole trader and limited companies

When deciding between a sole trader and a limited company, the amount and type of tax you’ll have to pay are likely to play a role. The profit of a sole trader’s business is subject to income tax. A contractor who works through their own limited company will pay corporation tax on the company’s profit and income tax on any compensation or dividends received.

However, we’ll break each of the structures down below:

Sole trader tax responsibilities:

• The annual self-assessment tax return is used to pay income tax on the business’s profits.
• National insurance contributions Class 2 and 4.
• VAT registration may be required based on your business situation and current VAT thresholds.

Limited company tax responsibilities:

• Self-assessment tax returns are used to collect income tax.
• Corporation Tax on taxable company profits.
• The annual accounts and confirmation statement for your company must be filed with Companies House.
• Employees and directors are paid a salary by the company, which is subject to PAYE.
• HMRC payroll reporting is required regularly.

Business expenses for sole traders and limited companies

You will incur expenses when running your business, whether as a sole trader or a limited company. You can lower the amount of tax you pay, whether you’re personally claiming tax relief on business expenses or running your business through a limited company.

You can claim expense items, mainly those for a limited company, as a sole trader. As a sole trader, depending on what you pay for personally (i.e., from your bank account), you may be able to get it back from the HMRC. There are many allowable expenses for sole traders, such as:

• Office costs (stationery or phone bills).
• Travel costs (fuel, parking, train, or bus fares).
• Clothing expenses (uniforms).
• Staff costs (salaries or subcontractor costs).
• Things you buy to sell on stock or raw materials.
• Financial costs (insurance or bank charges).
• Costs of your business premises (heating, lighting, business rates).
• Advertising or marketing (website costs).
• Training courses related to your business (refresher courses).
• Food cost (cost occurred when on a business trip).

These are all the allowable expenses that sole traders can claim back from HMRC as tax relief.

Limited company expenses you can claim from Companies House are as follows:

• Health check and eye test expenses.
• Business insurance expense.
• Advertising, marketing, and PR expenses.
• Accommodation expenses.
• Bank charges.
• Childcare expenses.
• Use of home as office.
• Gifts, entertainment, and trivial benefits.
• Professional subscription expenses.
• Phone bills.
• Equipment expenses.
• Professional development expenses.
• Travel expenses.
• Start-up costs.
• Salary.
• Pensions.

Sole trader vs limited company pensions

Retirement involves more than just contributing to a pension; it’s about saving for your future. Additionally, saving for retirement can help reduce your tax bill.

Sole traders can only contribute to a personal pension, while limited companies have the option to contribute to both personal pensions and other tax-sheltered investments. One of the advantages of being a limited company is the ability to establish a workplace pension scheme, which allows for more tax-efficient contributions.

As a sole trader or a limited firm, you must pay yourself.

As a sole trader, it’s best to pay yourself throughout the year without impacting the taxes you owe. You can choose to use an accrual accounting method if you prefer. This is because the earnings from your business belong entirely to you. They do not become part of the company’s finances until you pay the taxes on them, and there’s no way to pay yourself in a tax-efficient manner before that.

Owners of limited companies must consider various factors when making payments to their business. They can choose to make payments in the form of salary, dividends, or capital repayments. However, these options differ in their tax implications.

Suppose a contractor’s income is approaching the higher tax brackets. In that case, they can lower the amount of money they take from their company until the next tax year, when everything is reset to zero.

A combination of salary and dividends is one of the most popular ways to pay oneself through a limited company. This will allow you to operate tax-efficiently and compliantly while earning a higher profit.

Selling your business

Capital Gains Tax rules and allowances change frequently. Seek professional advice before selling a business or shares. To keep this article accurate, our team reviews and updates tax references, including Capital Gains Tax rules and allowances, which change frequently. It is advisable to seek professional advice before selling a business or shares. To ensure the accuracy of this article, our team regularly reviews and updates tax references, ideally at least once a year or whenever there are significant regulatory changes. Ideally, at least once a year or whenever major regulations change.

Limited company owners need to consider the tax implications of selling shares in their business, especially if they withdraw profits. When selling shares, they will be required to pay CGT (on money received individually) and corporation tax (on any company profit).

Picking either a sole trader or a limited company is troublesome.

Finally, weighing the differences between a sole trader and a limited company would be beneficial, as the business structure you choose can affect everything from profits to paperwork. Don’t make hasty decisions, and if you’re unsure, consult one of our chartered certified accountants, whose knowledge of tax and business structures is often invaluable.

In addition, regardless of the structure you choose, consider insurance because each business structure comes with its own set of risks. So, it is essential to learn more about sole trader and limited company insurance, and to get a general outline of the requirements you’ll need.

If you choose to incorporate, read our guide on Transferring Your Business to a Limited Company to learn about the process.

FAQ’s

How Naseems Accountants can help

Our objective at Naseems Accountants is to assist you in reducing administrative work and tax obligations, and in simplifying the tasks that get in the way of you doing what you do best.

We are committed to providing you with the best guidance possible. Based on your priorities, we will recommend an appropriate business structure to ensure that you are on the right track. You can count on our support throughout your career as we offer the guidance you need.

We understand that your work style may not follow the traditional 9-to-5 schedule, and we accommodate that. Our online portal allows you to manage your account at any time, day or night. Additionally, our extended operating hours enable you to chat with one of our chartered certified accountants whenever it is convenient for you.