Choosing the right legal structure for your business is one of the most important decisions you will make as an entrepreneur. Whether you decide to operate as a sole trader or a limited company can have a significant impact on your business, ranging from tax implications to liability issues.
In this beginner’s guide, we will explore the advantages and disadvantages of each business model, so you can make an informed decision that will serve your company’s needs as it develops.
Section 1: Introduction
When starting a business, one of the first things to consider is the structure and legal status that will work for you. Should you operate as a sole trader or as a limited company? Deciding on a structure is crucial, as it can impact almost every aspect of your business.
In this article, we will discuss the fundamental differences between sole traders and limited companies. We will explore the advantages and disadvantages of each, including how much tax you will pay, what earnings you can make, and even what happens should your company get into difficulty.
Section 2: Sole Trader
A sole trader is a self-employed person with full ownership of their business. The owner operates the business as an individual, so there is no legal separation between the business and the owner themselves. As a result, a sole trader assumes full liability. To become a sole trader, you must register using the government portal within three months of founding your business.
Section 3: Limited Company
A limited liability company is a separate legal entity from the identity of the owner. As such, it has a unique company identity, which must be registered (for a small fee) with Companies House. Because of this, there may be more than one owner or director, and they will have limited liability. This means that their personal finances won’t be affected should the business struggle financially.
Section 4: Sole Trading vs Limited Companies: Which is Right for Your Business?
For many smaller businesses or self-employed tradespeople, being a sole trader offers a few financial advantages, but it also brings an increased level of risk. Becoming a limited company can protect owners from these risks by giving them limited liability, but it can also mean a lot more admin and fiduciary duties for the directors.
In this section, we’ll discuss the benefits and negatives of different aspects of both models, including earnings potential, tax efficiency, and liability.
Earnings: Sole traders keep all of their earnings after tax, which is paid via the self-assessment system. This means that your earnings are entirely dependant on your performance that year. The owners of a limited company draw their earnings in the form of a salary, which is taxed at standard PAYE rates. They can also draw their earnings in the form of bonuses and dividends, subject to overall performance.
Tax: Because limited companies are registered at Companies House, they must pay corporation tax. For large companies, the rate of corporation tax is lower than it is for sole traders. Unlike limited companies, sole traders are not legally obliged to pay corporation tax. Instead, they are required to pay income tax at the standard rate and make National Insurance contributions on all profits: these are set at Class 2 rate if your profits are £6,515 or more (for tax year 2021/22), and Class 4 if your profits are over £9,568 (for tax year 2021/22).
Responsibilities and Personal Liability: Being a sole trader allows you complete control of your business, but it comes at an increased level of personal risk. Under UK law, there is no legal distinction between your assets and those of the company, so if you run up debts, creditors have the right to claim your personal assets. Directors in a limited company have limited liability, so they are unlikely to be held accountable for debts or lawsuits incurred by the business.
Section 5: Conclusion
When deciding between a sole trader and a limited company, it ultimately depends on what sort of company you want to start. Small businesses and self-employed tradespeople may prefer the simplicity and control over earnings offered by sole trading, while those aiming to start a larger company with many employees might be tempted by the security that registering as a limited company offers. It all boils down to your individual business model and future goals.
In conclusion, both business models have their advantages and disadvantages. As an entrepreneur, it’s vital to weigh up the pros and cons of each legal structure and make an informed decision. We hope this beginner’s guide has been helpful in giving you an overview of the differences between a sole trader and a limited company.
Limited Company or Sole Trader – Key Comparisons
Section 1. Legal Status
Section 2. Setting up
Section 3. Paying yourself
Section 4. Tax returns
Section 5. Tax efficiency
Section 6. Can you sell your business on?
Section 7. Is your company name protected?
Section 8. Is your personal financial liability protected?
Mart Abramov is the CEO of digital tax accountancy, TaxScouts.
To learn more about legal structures or create a company, visit our website, where we provide further resources for entrepreneurs looking to start their own business.