Sole trader or limited company?

by | Mar 9, 2022

ABG, London based Chartered Accountants and business advisers have been helping sole traders, limited company owners and LLP Partners decide on the most appropriate business structure for more than 55 years.  Our team of experts can help you opt for the correct legal structure under which you can operate your business but getting this wrong can have long-lasting ramifications on your obligations.

It is imperative that you pick the right one for your business and you seek professional advice from the outset.

For many new or prospective business owners, the choice will be between running a business as a sole trader or a limited company. They are vastly different from one another, and have several advantages and disadvantages that you need to consider before you choose to incorporate your business.

Difference between a sole trader and a limited company

The main difference between a sole trader and a limited company can be derived from their names.

For starters, a sole trader is solely responsible for the business because according to law, they are the business.

In other words, there is no difference between a sole trader and their business, legally speaking.

So, if you’re a sole trader, you earn what the business earns, own what the business owns and even owe to creditors what your business does.

This is not the case with the director of a limited company. Instead, legally, the two are completely separate entities – a company has its own finances, assets and accounts, and operates in its own name.

It is worth noting that a company can be a one-man-band and a sole trader business as large as it likes, contrary to what you might have been led to believe.

Sole trader advantages and disadvantages

There are several advantages to running your business as a sole trader.

First, it’s a very simple and flexible way to run a business. There is less paperwork, for instance, fewer registrations and just one tax return to do a year – your self-assessment tax return due every 31 January.

It is incredibly simple to start a business as a sole trader, too, as there is no need to talk to HMRC or Companies House – you can start trading right away.

However, all your business profits will be taxed as income, the three possible rates of which are all higher than the corporation tax companies pay, so if you make a lot, prepare for a higher tax bill.

Furthermore, because you are the business, your personal assets may be on the line if things start to go wrong.

Limited company advantages and disadvantages

As we mentioned earlier, a limited company owns its own assets, which means if it runs into trouble, the personal assets of the company director are guaranteed to be safe.

Limited companies also tend to receive a better tax treatment than sole traders, as profits are taxed at 19% as of the 2021/22 tax year – lower than income tax.

Of course, a company director has to extract their company’s profit as  income, but they do have tools at their disposal to keep tax down – perhaps even lower than the very successful sole traders.

To keep your tax bill as low as possible as the director of a limited company, you should keep your salary below the threshold for Class 2 National Insurance so you don’t have to pay.

You should then top up your payments with dividends, which are also taxed at a lower rate than regular income.

However, running a limited company is difficult. There are extra responsibilities, for instance, including registering with Companies House, corporation tax and statutory records.

It is also costly, but these costs can be offset if you’re making enough to really benefit from the tax treatment.

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