Limited company or sole trader? Which is right for me?
By PaperRocket Accounting, Nov 20 2018 10:38AM
So, you’ve made the decision to move away from the employed life and become self employed. When it comes to self employment, there are three main options; 1) set up a limited company, 2) act as a sole trader and 3) work through an umbrella company. But, which is the right route for you?
We’ve already looked at the differences between working through a limited company vs through an umbrella, so in this blog, we take a look at the differences between a limited company and working as a sole trader.
What is a sole trader?
Out of all of the options of self employment, working as a sole trader is arguably the simplest, as the sole trader is the self employed person who owns the business. You will need to register as self-employed, but keeping the accounts is relatively straightforward as everything just gets declared on your self assessment return.
Tax and national insurance
As a sole trader, you will need to pay two types of NI. Class 2 if your profits are £6,205 or more annually (at a flat rate of £2.95/week) and class 4 if your profits are £8,424 or more annually (9% on profits between £8,424 and £46,350, then 2% on profits over £46,350).
A sole trader will also pay income tax on any business profits made (after deductions for expenses). This is calculated on the self assessment return for the year.
• Easy to set up and much less paperwork than a limited company- all company profits are declared on a self assessment tax return, rather than having to compile company accounts. It is still advisable to have an accountant to advise and guide you on the accounting side of your business, but on the whole, you will pay an accountant much less as a sole trader than as a limited company.
• Arguably less commitment than a limited company, which may be preferential for people ‘dipping their toe’ into the world of self employment, or people who are using it as a side-line business with less profits. For many, it acts as a stepping stone from the world of PAYE employment to setting up their own limited company.
• Greater privacy for the sole trader as this route does not require registration at Companies House (where company details can be found online).
• It is generally more tax efficient to have a limited company, particularly when business profits are higher (this is why many sole traders will set up a limited company once the business takes off).
• A sole trader is not seen as a separate entity in UK law- this means that there is no limit to liability which in turn means that if the business gets into debt, then the sole trader themselves becomes personally liable, meaning their personal assets can be at risk.
• It can be trickier obtaining contracts or raising finances as clients, investors and banks tend to prefer limited companies, which can mean that sole traders may find it harder to expand.
What is a limited company?
A limited company is a business with its own legal identity, with shareholders and directors. It will need to be set up at and registered with Companies House (many accountants will take care of this for you) and HMRC, and various filings will be required, such as company accounts, tax returns and confirmation statements.
Tax and national insurance
A limited company will be required to pay corporation tax, currently at 19%, on its profits (after expenses). It may also have to pay VAT (if registered). We cover the various related taxes in this blog. The shareholders will also be required to pay tax on any dividends received on their self assessment return.
Limited companies are only required to pay employers NI if they have employees earning over the relevant threshold, or if they provide benefits in kind to their employees.
• A great benefit of trading through a limited company is the limited liability that it brings. Because the company is a separate legal entity to the directors/shareholders, any company debt is restricted to the company, and no personal assets are at risk. You only stand to lose what you put in to the company.
• On the whole, it is more tax efficient to work through a limited company. It allows you to leave funds in the company, only withdrawing them when required/is tax efficient. Limited companies do not have to pay the national insurance that a sole trader does, and there is also a wider range of expenses that a limited company can claim to reduce company profit (and therefore corporation tax).
• Having a limited company can add an element of prestige and professionalism to your business which may help with the company’s prospects. Also, once a company name has been registered, no one else can use it (unlike with sole traders)
• Possibly the biggest disadvantage of having a limited company is the level of responsibility it brings, and the amount of admin. As mentioned above, a company director is responsible for the filing of annual accounts, tax returns, confirmation statements, VAT returns (if registered), PAYE returns (if registered), on top of their own annual self assessment return. If you set up a limited company, you will almost certainly require an accountant to assist with this.
• Unlike with sole traders, you will be required to register your details with Companies House, which will mean that your details, company earnings and, if you do not use a registered office service, your personal address will be available to view.
• Setting up and, particularly, closing down a limited company can be costly and time consuming. Therefore, it is not something that is advised you just ‘try for a few months’. You should be committed to having a limited company and ideally, have plans to work through it for at least 12 months, for it to be worthwhile.
So, deciding whether to work as a sole trader, or through a limited company is not a decision to be taken lightly. Luckily, whichever option you choose, PaperRocket Accounting have you covered, with Sole Trader packages starting at just £40 plus VAT/month, and Limited Company packages at just £95 plus VAT/month.
PaperRocket Accounting provide accounting and tax services to professional contractors and freelancers working in the UK.
We offer our clients a flexible choice of fixed fee monthly packages which cover all of their accounting and tax needs (so no hidden costs or surprise bills!). All of our accounting packages include a monthly subscription for a cloud accounting software subscription provided by the awarding winning FreeAgent.
Each of our clients is given their own dedicated qualified accountant with unlimited access in person, telephone, or by email.
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