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1st October 2021

One of the most frequently asked questions we accountants come across seeks to answer what trading vehicle people should choose. The answer depends on a variety of factors, which we look at towards the end of this blog, but first, let’s see what the differences are between being a sole trader and running a limited company.

Business structure and responsibilities

Sole trader

As a sole trader, you are working as an individual and carry the responsibilities of your business, such as paying the bills, keeping sales and expenses records. There is no legal distinction between you as an individual and your business, so you are personally responsible for any losses your business makes.

Limited Company

A limited company is a business structure where the shareholders are only responsible for their individual investment, hence the name: limited. There are two main limited company structures that exist:

Private (LTD) companies limited by shares – Most small businesses and freelancers use a private limited company where shareholders own the company divided by shares that cannot be sold on public markets.

Public limited company (PLC) – Limited companies of a certain size can offer their share for the public to purchase on stock markets to raise funds. In return, they then pay dividends to those investors.

Paying taxes

Sole trader

As a sole trader, like everyone else, you need to pay taxes and National Insurance. The only difference to those in employment is that you do it through an annual self-assessment tax return. To complete the return at the end of the year, it is crucial that you keep all income and expenditure records for the year. Your taxable income is then worked out on the tax return, and taxes and NI contributions are calculated.

If you are VAT registered, your records must be kept and submitted digitally per the Government MTD (Making Tax Digital) rollout.

Limited company

Paying taxes when you operate a limited company is a bit more involved, so you probably need a help of an accountant.

Because the limited company is a separate entity from you, it pays its taxes separately to you as well. Your accountant will prepare the annual accounts and your company tax return, calculating the profits and how much tax to pay.

Your income from your company comes from profits remaining in the company after tax (distributable profits/dividends) and the salaries you take. All this then goes on your self-assessment return, and you pay the taxes due.

Admin

As a sole trader, admin is pretty simple, you register for self-assessment online, and you are ready to go. Keep records of your outgoings and invoices and if you have to submit a quarterly VAT return. Instead of preparing company accounts, you just submit a tax return at the end of the year and you are done. There are so many apps and tools around to help you; if you are handy enough with them, you can do this yourself.

A limited company needs more involvement and increases your responsibilities as a director. From incorporation to annual confirmation statements, to accounts to corporation tax returns to reporting changes to Companies House, you probably need an accountant, unless you are one yourself.

Costs

Typically, and especially if you are just starting out, accountants charge less for preparing your tax return. Even if you ask them to do the bookkeeping and your VAT returns, you will likely pay less than someone with a limited company. Cost can increase, though if your business has grown to a certain level, at which point it might be worth having a look if switching to a limited company structure offer any benefit.

If you run a limited company, and your accounts are relatively simple, you can find fixed fee accountants to help you, but as your business grows, expect to pay more as they spend more time sorting out your books. You can see cheap monthly fees out there, but if you go for those, expect to do some of the work yourself.

Pros & Cons

Let’s compare the pros and cons of each trading vehicle below.

Sole trader Pros

  • Simple set up – Register online
  • Cheaper running costs – Lower accountancy fees
  • Less admin – Record your income and expenses and file a tax return
  • More privacy – Your name doesn’t appear on public records
  • Complete control – No shareholders, so one else owns part of your business

Sole Trader Cons

  • Unlimited liability – You take financial responsibility for your business
  • Not very tax-efficient above a certain income
  • Fewer business opportunities – Businesses generally prefer to deal with limited companies

Limited Company Pros

  • Limited liability – Your personal assets are protected
  • Better employability – Many firms only deal with limited companies
  • Tax efficiency – Better take-home rate above a certain income
  • Easy to upscale – Raise funds by selling shares
  • Hold onto your Brand/Business name  – Company name protected

Limited Company Cons

  • More admin & responsibilities – Various forms, accounts, tax returns to be filed
  • More expensive to run – Higher accountancy fees
  • Less control if you have more shareholders – Selling shares could divide up control over the company
  • Less privacy – Your name is available at Companies House public register

Which one is best for you?

A question asked by many, and the answer lies with you and your circumstances. We recommend asking an accountant who can work out which one best suits you and your business at that specific stage in your journey.

Keep your goals in mind when seeking the answer to which trading method is best. Here are some simpler examples where the answer is more straightforward:

Say you are a freelancer and just starting a side hustle; you’ll be better off as a sole trader, and if everything goes well and your business grows, you might end up incorporating for better tax efficiency. Here are some examples of many just to show you how individual circumstances may differ:

  • IT and business consultancy contractors almost exclusively operate through a limited company because their end client would only deal with limited companies.
  • Consider your plans. Do you want to raise capital, perhaps protect your brand? Then incorporating is the way to go.
  • Would a limited company structure be better if you want to expand your rental property portfolio?

We hope this article has helped answer some of your questions about the differences between being a sole trader and limited company trading.

To find out which is the best fit for you and see how MyAccountant can help, please get in touch either by sending an e-mail to info@myaccountant.co.uk or calling us on 0800 917 9100.

If you’d like to see more articles like this, please visit the blogs section of our website and follow us on LinkedIn, Facebook or Twitter.

 

 

 

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