When you are starting out as a business there are lot of decisions to be made – one of the most important is to decide whether to setup as a limited company or sole trader. It’s important to understand what they both mean and which structure is more suitable for your circumstances.

Sole trader

This is the most straightforward way for many freelancers or contractors to begin their career as all that is required is to register with HMRC as self-employed within 3 months of trading and then pay National Insurance and Income tax. This structure requires minimum administration and involves submitting a self-assessment tax return every year. Hence, it’s more popular amongst contractors or traders engaged in construction, plumbing, electricians and transport.

Sole trader structure is usually less tax efficient as the individual is the business and hence pays personal tax on the income generated. Further, there is no legal distinction between the personal and business finances, implying personal assets can be considered to settle business liabilities like debts or loans.

Limited Company

Limited company on the other hand is the most tax efficient way to trade and minimise personal liability. Limited company is considered as a separate legal entity from the owner and hence the liability is limited, implying they’re not personally responsible for any liabilities incurred by the company.

The below table summarises the fundamental differences between both the structures

Comparatives  Sole Trader  Limited Company 
  Administration  Low Administration.
There are less statutory obligations. 
High Administration.
There are greater statutory obligations as a Director. 
Liability   You are personally liable for your own finances and possessions may be at risk if things go wrong.  You are treated as separate from your limited company; you are protected (provided you meet your statutory responsibilities as a director) from the threat of personal financial losses if things go wrong. 
Costs and Accounting   Setup cost involved is low and the paperwork is very simple as there is no requirement to register your business at Companies House. You only need to inform HMRC within 3 months of trading. Also, accounting is simple and less costly.  Setup cost is high as various registrations are required with Companies House and HMRC. Moreover, because of a range of statutory obligations accountancy cost is usually higher. 
Status   Some companies look more favourably towards limited companies and recruiters typically will not engage with Sole Traders.  Some companies view a limited company in a more positive manner. Larger companies may refuse to transact with anything other than a limited company. 
Tax Planning   Limited scope for tax planning. There are tax planning opportunities like spousal dividend planning, timing of dividends etc. giving you more flexibility hence tax savings 
Confidentiality   Information is kept private and confidential and is not available to the public as opposed to a limited company.  All information like Director’s details, annual accounts and companies trade is publicly accessible. 

Frequently Asked Questions

In the UK, limited companies are the most common type of company. It's a corporate entity which is considered separate to those who own and operate it. Fundamentally, this means that the company can possess assets or enter a contract in its own name, rather than that of the stakeholder.

You might be wondering what does the word 'Limited' in Limited Company mean? This refers to the limited liability afforded to shareholders. It means that shareholders are only responsible for the company's debts, to the value of their shares. Essentially, having limited status means that your company is —in its own right - an entity.

Your Limited Company is established once it has been incorporated. Incorporation also referred to as company formation, involves registering the company with the UK's registrar of companies: Companies House.

What does this mean? Above all, it means that you'll no longer take full responsibility for the company and its tax, national insurance, and other finances. Moreover, the company's finances will be completely independent of your own. In the same way, any profit made from the company is thus owned by the company after it pays its corporation tax. The profits can then be distributed among its members (those people or organisations who have shares in it).

It's important to note that a limited company provides you with added protection if things go awry with your business. Also, it might be easier for you to take our business loans and secure investment.

Because a limited company is a distinct entity from its owners, it may be a little easier for a company to secure business loans and investment. What's more, a limited company might benefit from tax advantages, too.

What happens to a limited company once you retire or resign? The company will continue to exist and operate, ensuring job security for employees.

So, what's the difference between limited and sole trader? It can be challenging to wrap your head around the differences. That being said, the main difference between sole trader vs limited company can be seen in the way that taxation and legal liabilities are applied.

As a sole trader, there's little legal distinction between you and your business. This means that your assets aren't protected. Moreover, all business debts come back to you. A limited company, on the other hand, is a legal entity on its own and therefore the liability shifts to the company. This means that there is less personal monetary risk involved with limited companies.

Setting up as either business structure has its advantages and disadvantages. Fundamentally, it all comes down to your business needs. However, there are some key factors that distinguish these two business structures which we can use to weigh them against each other.

Setting up as a sole trader is relatively simple. All you need to do is file a self-assessment tax return on your annual accounts. It does mean keeping track of all your business transactions and expenses, however, you can always hire an accountant to do that. Once you've filed those taxes you get to keep all of the profits earned from your business and claim the expenses, as opposed to dishing them out to various shareholders or employees. Choosing to go solo as a sole trader means you can maximise your salary and operate with minimal costs. Moreover, you can enjoy greater privacy than incorporated businesses. For more information read our sole trader advantages & disadvantages guide.

On the other hand, setting up as a limited company allows you to enjoy limited liability as there's a legal distinction between you and your business. So you'll only stand to lose that which you invest in the company. This structure is a good idea for small businesses who need greater legal rights to grow with shareholders and employees. For more information read our limited company advantages & disadvantages guide.

It's also a more tax-friendly way to operate, as the company must pay corporation tax on profits rather than income taxes, which are taxed at a higher rate. Moreover, once you've registered your small business company name no one else can use it. Adversely, sole traders aren't offered the same protection.

So, what's better: sole trader or a limited company? There's no definitive answer to this question, as it all depends on your business needs, plans for the future, and what works best for you. If you want to grow and expand your business and reduce liability, then operating as a limited company could well be worth your while and the most efficient way to handle and pay tax and national insurance finances.

If you're confused about whether you should be a sole trader or limited company, there are some things you'll need to consider before making the switch.

The first point to consider is your salary. How much are you earning? If your earnings are relatively low, then it's likely you'll also want to keep your accounting and tax as simple as possible. The sole trader structure is definitely easier to manage, as you'll just have to send a tax return at the end of the year. To do this you might consider hiring an accountant to help organize and track your accounts and expenses. Operating as a limited company usually incurs higher accountant fees than sole traders, but saves you from running around trying to track down all your accounts when the time comes!

As your small business as a sole trader grows, your profits are likely to grow too. Unfortunately, so will the amount of taxation you're required to pay. If your earnings increase, you may need to consider forming a limited company to pay corporation tax instead.

When making this decision it's important to weigh up your overall earnings with the taxation rates you'll need to pay as a limited company director. This will help you to understand whether the costs of running your business as a limited company are going to be worth your while, or if it'll affect the salary you'll take home at the end of the day.

If you're a small business owner and decide to switch from operating as a sole trader to a limited company structure, you'll find there are several advantages. Let's take a closer look at some of the best advantages of making the switch.

1. Limited liability

Changing to a limited company means you, as director, won't be personally liable for any debts your business might incur as the company is a separate entity. This gives you an added level of protection and ensures you won't find yourself caught between a rock and a hard place if things go awry. Your business success isn't always solely dependent on your efforts - there are a number of factors at play - so you must ensure you've got the protection you need just in case things don't go as planned.

With this in mind, as a limited company business owner, it's a good idea to keep separate bank accounts for your finances and your business's. A business bank account could help you to keep track of everything and avoid any taxation surprises.

2. It's more tax-efficient

Sole traders pay taxes on the business profits they make. However, this only happens when you earn more than £11,000 per year. Once your income is more than this as a one-person self-employed sole trader, you could find yourself paying high taxation rates if you earn over £150,000 per annum.

As a general rule of thumb, if you earn up to £30,000 per year you should start thinking about incorporating your business. If you own a growing small business and are wondering whether to switch to a limited company, it's a good idea to consider the amount your business makes.

By changing to a limited company setup, you'll find plenty of benefits when it comes to paying less in personal taxation amounts. You'll be liable for paying corporation instead of income tax on your profits, which is currently set at 18%.

3. Protect your business name

When you incorporate your business you'll need to register its legal name with Companies House. This means it's fully protected, providing insurance that no one else can operate under the same name. This allows you to grow and gain recognition as a business or brand. Moreover, it's a handy advantage if you want to secure a website name, create business cards, or have a logo designed.

4. Reach new levels of professionalism

What do you think of when you see a business name with "Ltd" at the end? That it must be professional, trustworthy, and reliable - right?

Transitioning to a limited company business structure could boost your business to new levels of professionalism and prestige that'll encourage potential clients and existing customers to take you seriously as a business, and —hopefully - invest in your products or services!

There are a few key disadvantages of being a sole trader. These include:

  • Sole traders have unlimited liability. If you run your business this way, the business owner is fully responsible for any debt incurred.
  • Raising finances can be more difficult as banks, insurance companies, and other investors prefer limited companies are they offer more security.
  • Taxation rates for sole traders aren't usually as kind as those for limited companies. Once you reach a certain amount of earnings, you'll have to pay more in taxation. As a company director, it might not be the best option if your business is growing.

DNS offers a full range of Sole Trader services at a fixed annual fee with no hidden costs. We can register you with HMRC and assist in filing VAT returns, preparing sole trader accounts and advise on expenses. Please contact us on 0330 088 6686 to find out more.

How We Can Help?

If you are still not sure which is the right option to run your business or if you have already setup and want to understand tax mitigation strategies, then DNS Accountants can help you. For more information on the support we can offer please contact us today.

Why Choose DNS?

  • Award Winning Accountancy Firm 
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Please speak to one our experts today on 0330 088 6686.