Choosing whether to operate as a sole trader or limited company is one of the first choices you’ll need to make when beginning your own business. At the start of 2021, there were 5.6 million registered enterprises, according to the Office of National Statistics. 3.2 million (or 56%) of them were sole proprietors, 2 million (or 37%) were registered limited corporations, and 384,000 (or 7%) were regular partnerships.
Being a single proprietor may therefore be the most common choice, but limited companies are closely behind, and this article will explain why. Both business models have benefits and drawbacks that should be taken into account before choosing one.
One of the most crucial choices a new business owner must make is the legal structure, yet it can be challenging to comprehend your options. The distinctions between operating as a sole trader and a limited company are explained in this guide.
What’s the difference between a sole trader and a limited company?
It’s vital to understand the differences between operating as a limited company and a sole trader.
In the case of a limited company, the business is viewed as a separate legal entity from its shareholders and directors, whereas for sole traders, the self-employed business owner and the business are recognised as one legal entity.
This implies that a sole trader is accountable for both personal and commercial debts, putting personal assets like a home and car at risk in the event of a financial emergency or claim against the business. The finances of a limited company, in contrast, are distinct from the shareholders’ or directors’ personal finances, thus they are only exposed to the money they invested in the company.
Another significant difference is paperwork. There are fewer procedures involved in operating as a sole proprietor, but there are many more for limited businesses, including filing accounts, registering with Companies House, and complying to stringent record-keeping guidelines.
Is it better to be a sole trader or a limited company?
Depending on your specific situation, you can choose the ideal business form. Being a sole trader or limited business has both benefits and drawbacks.
Although sole ownership is the simplest business form to set up and requires the least number of paperwork and commitments, you may find it more difficult to obtain business financing, take advantage of tax breaks, and draw in clients.
Although forming a limited company is more difficult, more expensive, and time-consuming, there are several benefits, including the ability to raise capital, improve your firm’s standing with clients, and become more tax-efficient.
Advantages of being a sole trader
- Start right away: You can launch your firm as soon as you desire because Companies House registration is not required.
- Hardly any paperwork: You don’t need to pay Corporation Tax or file company accounts with the Companies House; you just need to submit a self-assessment tax return once a year. In contrast to limited businesses, which must adhere to tight record-keeping standards.
- Control over your company: Since you are the only person, all decisions can be made without consulting any partners or stockholders.
- Maintain everything: You operate your company as an individual and keep all of the earnings you make after paying taxes.
Advantages of being a limited company
- Limited liability: Because shareholders and directors are legally separate from a limited company, any losses incurred by the firm are not subject to your personal culpability. Whereas sole traders have unlimited liability and are wholly responsible for any claims against the business..
- Greater tax efficiency: A limited company structure gives you the chance to run your firm more profitably. Limited corporations pay 19% corporation tax (due to rise from 1 April 2023), making them generally more tax-efficient than single proprietors who pay 20% to 45% in income tax. Additionally, they are eligible for a greater variety of benefits and tax-deductible expenses. Whilst corporation tax may be lower, Director/Shareholders will have to pay tax personally if they choose to withdraw dividends or a salary from the company. Dividends are taxed at a lower rate than salaries and do not trigger National Insurance but you should read our guide X.
- Funding: As a limited business, you have more options for obtaining funding. Due to the level of legal protection and tax advantages that limited companies enjoy over sole proprietors, business financing lenders and investors tend to prefer them.
- Greater credibility: Conducting business as a limited company can foster greater confidence and trust among vendors and clients. Some corporations might not collaborate with non-limited companies.
Can I change from being a sole trader to a limited company?
As the simplest business structure to set up, becoming a sole trader is a viable option for many small business owners and self-employed people launching their own venture. However, there may come a time when you determine that being a limited corporation is preferable, and switching over is entirely feasible.
You may choose to switch your firm’s legal form to a limited corporation for a number of reasons. They consist of:
- You want to be more tax-efficient because you’ve noticed in your annual accounts that profits are rising.
- You’re trying to raise money for your business.
- You want to improve your company’s standing and perception among current and potential clients.
- You want to hire fresh talent.
Switching from sole trader to a limited company can be a difficult decision, so it’s recommended that you discuss your options with an accountant.
Sole Trader vs Limited Company Tax Requirements
Sole Trader Tax Requirements
Each tax year, from April 6 to April 5 of the following year, sole proprietors must pay income tax based on their profits.
Additionally, Class 2 and 4 National Insurance contributions are due from sole proprietors.
You are permitted to take into account reasonable business expenses and deduct them from your income when calculating the amount of tax you must pay. These costs could consist of:
- Advertising and marketing.
- Components or stock.
- Internet or phone (for business use only).
- Rent for the space.
- Utility invoices.
- Travel costs, petrol for a company vehicle, etc.
Based on your yearly profits, you will pay tax as a sole trader. Your profits are determined by subtracting your business expenses from your self-employment income.
Limited Company Tax Requirements
The primary tax owed by limited companies is corporation tax. In contrast to single proprietors, limited firms pay corporation tax on business profits after deducting any permissible expenses, rather than income tax or national insurance.
After paying employees and other permissible business expenses, but before dividends are received, corporation tax is imposed on limited company profits.
For the fiscal year 2022–2023, the current company tax rate is 19%. The amount of profits the business made at the conclusion of the tax year will determine how much of that 19% tax your company really owes HMRC. However, corporation tax rates are set to rise from 1 April 2023 with the applicable rate dependent on your company profits.
Contrary to income tax, which is paid by sole proprietors and PAYE workers, corporation tax does not have a tax-free exemption.
Looking for Expert Support with your Small Business Tax?
If you’re a sole trader or a limited company and you need help with anything tax related, get in touch with our knowledgeable accountants here at RAW Accounting.
Our expert team can offer a wealth of advice on small business tax, from self-assessment to corporation tax, we’ll make sure you’re adhering to guidelines and most of all making the most out of your business.
Contact us today for a free discovery chat!
Sole trader vs Limited Company Tax FAQs
Will a limited company pay less taxes?
When it comes to personal taxes, the limited company option can be more tax-efficient. Typically, you’ll take home a modest wage (with little tax obligation) and receive the balance of your income as dividends (which are free from National Insurance).
When should I move from sole trader to limited company?
Your tax and accounting obligations as a sole proprietor will be rather straightforward. It becomes more cost-effective to switch to a limited company structure as your earnings start to increase and you may reduce your tax liability.
Can I change my bank account from sole trader to limited company?
You must register a new business bank account for the limited company if you switch from operating as a sole proprietor to one.
