Your business structure is one of the first things you’ll need to decide on when you start up, but how do you know which is right for you? Sole trader or limited company?
It’s an important choice, determining where your business stands in legal terms, the kind of tax that applies to it, and what your responsibilities will be when it comes to record-keeping and reporting.
There are several different structures to choose from, but we’ve summarised the main advantages and disadvantages of two of the most common ones: sole trader or limited company.
Sole trader or limited company – which is best?
Choosing to trade as a sole trader or limited company can be a difficult decision to make. You must take into consideration whether it’s a new or existing business, the future plans of the business and the tax implications of the choice you make.
While it is possible to change the structure of an existing business – and in many cases, this can be a good idea as your business gets bigger and more complex – it’s still best to go in with a clear plan, and choose the most suitable structure for your business from the beginning.
Benefits and drawbacks of a sole trader structure
Working as a sole trader is the simplest business structure – effectively, all you need to do is start trading for this label to apply to you. Your business finances and your personal finances are one and the same, and you’re entitled to all the profits your business makes as your own income.
This makes things relatively easy to run from an admin and regulatory perspective. You’ll be required to register with HMRC for self-assessment, and pay tax each year by filing your tax return, and you’ll need to keep records of your business’s sales and expenses. But besides that, you won’t have a huge amount of paperwork, or anything to report to Companies House.
The downside of this is that you don’t have any protection when it comes to the financial side of your business. You’ll be personally responsible for any debts your business has – and if things go badly wrong, that could mean losing your personal assets or even facing bankruptcy.
Benefits and drawbacks of a limited company
Limited companies provide a main advantage that the sole trader structure doesn’t – legal separation from your business.
Your company exists as a separate legal entity, with its own income and debts. From HMRC’s perspective, you’re not your company, even if you’re the only person in it. Instead, you’re its owner and employee.
This gives you some protection in the event your company faces financial difficulty, so there’s less risk you could lose your home and possessions. This can be reassuring to stakeholders and lenders, and in some cases it just helps to create a sense of professionalism.
The main disadvantage of running a limited company compared to working as a sole trader is its complexity, and the admin that comes with it. There’s a lot more to get to grips with when understanding how a company is run, from shares and shareholders to your record-keeping and accounting responsibilities. You’ll be required to register with Companies House, prepare the right documentation, and file annual accounts alongside a corporation tax return.
Tax saving opportunities for limited companies
You might have heard that a limited company is the best option because it’ll save you tax. There’s some truth to this – in many cases, running a company can be more tax-efficient. But it’s essential that you do the sums for yourself (or, even better, get a qualified professional to do them for you) before jumping to any decisions right away.
A limited company can keep any profits it makes after paying corporation tax on them, at a rate of 19% in 2022/23. Compared to the income tax rates of 20%, 40% and 45% a sole trader would need to pay on all profits, it’s easy to see the potential for savings.
To access money from the company yourself, however, you’ll need to extract it. There are a few different ways of doing this, including a salary, dividends and pension contributions, and each method comes with different tax rules and rates.
To really understand the tax difference a company would make for you, you’ll need to look at how you’ll be taking an income from it and calculate your tax position from there. Keep in mind, also, that the main rate of corporation tax is set to rise to 25% from April 2023, although different rates will apply depending on your business’s profits.
In any case, tax shouldn’t be the only thing you think about when choosing a structure. Make sure you understand the pros and cons of each option, and go with the one that’s most suitable for you.
We work with many different sized businesses and often guide business owners in taking the right steps with their business.
Still not sure? Get in touch for help choosing the best set-up for your business.