Sole Trader vs Limited Company: Which is Best For You? - VW Taxation Ltd

Sole Trader vs Limited Company: Which is Best For You?

More and more of us nowadays are taking the plunge and working for ourselves. One of the easiest and simplest ways to do this is to set up as a sole trader, essentially a self-employed person who runs their business as an individual.

A more complex approach is to set yourself up as a limited company. This has certain advantages in terms of tax and personal liability which can be advantageous in many industries and for a range of business models.

Here we look at the difference between being a sole trader and operating as a limited company and which is more likely to suit your current needs:

Is it best to be a sole trader or a limited company?

The question depends on what you want to achieve with your business and how it is set up. Some 3.5 million sole traders are operating in the UK and it’s by far the most popular legal structure, easy to manage and simple to set up. There are around 2 million limited companies, however, and these come with some distinct advantages.

If you are a sole trader, you are completely responsible for your business and its finances. If something goes wrong, you and your assets, including possibly your home and money, maybe at risk. With a limited company, you have limited liability as it is seen as a separate entity under the law.

For example, if someone sues your business, as a sole trader you will be personally responsible. If you own a limited company, it’s the company that is being sued and not you personally.

There are also some tax advantages when it comes to owning a limited company, especially if you have a significant turnover. Being a limited company generally gives your business more kudos – some other businesses are more likely to deal with a limited company than a sole trader. Raising finance can also be an issue as a sole trader and is much easier for limited companies for the same reason.

As a limited company, you have to register it with Companies House and produce annual tax returns. You will also need to file corporation tax accounts with HMRC.

It’s important if you take this route that you use a professional accountant who can ensure that your accounts are solid and go through on time. In general, there is more work involved in operating a limited company than there is a sole trader and more legal obligations. You are seen as a director and shareholder and take a wage and possibly share dividends rather than putting all the profits in your private bank account.

Sole trader vs limited company tax

One of the main differences between a sole trader and a limited company is how tax is handled. As a sole trader, you will sign up for a self-employed tax assessment with HMRC and submit this each year. You will pay the standard rates of income tax depending on your profits and NICs.

As a limited company, you are subject to Corporation Tax which generally has lower tax rates than for a sole trader. You and anyone else working for the company will be paid PAYE with National Insurance contributions. You can also have share dividends for your business and these come with allowances that can make them tax efficient.

Who pays more tax sole trader or limited company?

In general, limited companies tend to pay less tax than a sole trader but much will depend on what sort of business your run and the amount of profit you make. As a sole trader, all your profits will be subject to the standard rates of income tax for self-employed individuals.

As a limited company, you could, for example, pay yourself the minimum wage with a low tax cost and add in dividend payments, the first £2,000 of which is tax-free.

Is a sole trader the same as a limited company?

An individual can be the sole owner and employee/director of a limited company but they are not classed as a sole trader. A sole trader can take all the profits they earn without any disadvantage (once they’ve paid their income tax and NICs from their self-assessment). Any monies withdrawn from a limited company and given to the director will need to be taxed as they are classed as employment earnings.

How do I go from limited company to sole trader?

If your business does not go as planned after setting up as a limited company, you may want to revert back to a sole trader. You will need to formally wind down your company and produce final accounts. You may also want to discuss this with an accountant, especially with concern about any losses that might have been offset by future profits.

Once the finances are sorted, the company can be struck off the register. Working as a sole trader after this simply requires you to register with HMRC as self-employed.

Pros & cons sole trader vs Limited Company

The advantages of being a sole trader include:

  • It’s much easier to set up and manage as a sole trader, all you need to do is register with the HMRC for tax self-assessment.
  • Sole traders have a greater level of privacy and don’t have to lodge information with Companies House.

The disadvantages of being a sole trader include:

  • You have full liability for your business, including if you get into debt.
  • You could be at a disadvantage if you are bidding for contracts where vendors tend to prefer limited company status.
  • You can end up paying more tax and may not be eligible for certain tax reliefs.

The advantages of being a limited company are:

  • The liability is in the company rather than you as an individual.
  • Some clients may see you as more trustworthy because you are a limited company. This is often the case in areas such as the construction industry.
  • As earnings increase, limited companies can be more tax-efficient and help your business access things like bank financing.
  • Limited company names are protected which means you can stop someone else from benefiting from your success.

The disadvantages of being a limited company are:

  • There is certainly a lot more administration and paperwork involved with running a limited company and having a qualified accountant on board is a must.

Whether you are thinking of setting up a limited company or prefer to act as a sole trader, getting the right advice from a professional accountancy team is always important. If you need to discuss your business finances and whether you have the right setup for your needs, contact the team at VW Taxation in Portsmouth to find out more.

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Picture of Gary Ellis | Director | VW Taxation
Gary Ellis | Director | VW Taxation

VW Taxation are self employment tax specialists based in Portsmouth. We specialise in tax accounting for contractors, limited companies and the self-employed.

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