When embarking on your entrepreneurial journey, one of the initial crucial decisions you’ll face is whether to register as a sole trader or a limited company. This choice will significantly impact your business’s tax efficiency, making it a significant decision to ponder.

Each business structure has its own set of advantages and disadvantages, so the best choice for you depends on your specific circumstances. To assist you in making an informed decision, let’s explore the differences between operating as a sole trader and as a limited company.

What sets a sole trader apart from a limited company?

What are my liabilities as a sole trader compared to a limited company?

How do I pay myself as a sole trader versus a limited company?

Is being a sole trader more private than being a limited company?

Obligations and deadlines for sole traders and limited companies

Registering your new business

What sets a sole trader apart from a limited company? One key distinction is that when you establish a limited company, it becomes a separate legal entity from yourself as the owner. Any profits generated by the business belong to the company. On the other hand, registering as a sole trader means there is no legal separation between you and the business, making you and the business legally indistinguishable.

This distinction in the legal relationship between you and your business is of utmost importance as it affects your obligations as a business owner, reporting requirements, taxation as a business, and even how you pay yourself or claim expenses.

What are my liabilities as a sole trader compared to a limited company? As a sole trader, there is no legal separation between you and your business. Therefore, you are personally liable for any legal and financial matters, including debts. In the event of business difficulties, your personal assets could be at risk.

Certain industries carry greater financial risks, particularly those that require substantial upfront investments before receiving payment from clients. Such industries may not be ideal for operating as a sole trader.

The term “limited” in a limited company refers to the limited personal liability it offers to directors and shareholders. Any debts incurred are the company’s liability, not yours personally, providing greater protection.

How do I pay myself as a sole trader versus a limited company? From HMRC’s perspective, sole traders and their businesses are considered the same entity. As a sole trader, you are entitled to keep all after-tax profits generated by the business. In contrast, operating as a limited company establishes a complete separation between yourself and the business, meaning any profits belong to the company.

Since you aim to earn an income from your business, paying yourself from a limited company requires a more formal arrangement, usually involving a combination of salary and dividend payments.

The Basics of Paying Yourself Tax efficiency for sole traders and limited companies The method by which you pay yourself, whether as a sole trader or a limited company, impacts your tax efficiency. As a sole trader, where there is no legal separation between personal and business finances, you will pay Income Tax on your profits regardless of whether you use them personally.

In a limited company, profits remain within the business until you choose to pay yourself. As a company director, you can pay yourself a tax-efficient salary, subject to tax and National Insurance once you surpass the relevant thresholds. It’s essential to note that employers pay National Insurance in addition to employees, so exceeding the National Insurance threshold could result in paying it twice for the same income.

If you are also a shareholder, you can opt for a smaller salary (below the tax and National Insurance thresholds) and receive the remaining income as dividends. Dividends are payments made to shareholders from the company’s post-tax profits and are not subject to National Insurance. While you will still be required to pay tax on dividend income, the Dividend Tax has a lower starting rate compared to Income Tax.

You can use our calculator to estimate your take-home income as a sole trader versus a limited company.

Is being a sole trader more private than being a limited company? In a way, yes! Sole traders can run their businesses without the obligation to make information publicly available. On the other hand, limited companies must register with Companies House, and their information becomes accessible online.

While you can use a registered office address to protect your personal address, your name and annual accounts will be publicly available through Companies House, which publishes them online. If you’re operating a side business and prefer to keep it confidential from your employer, this is something to consider.

Reporting obligations and deadlines for sole traders and limited companies Regardless of the chosen structure, you must maintain detailed records of your business’s financial activities. However, being a sole trader generally entails slightly less administrative work than running a limited company.

Sole traders pay Income Tax and National Insurance on their profits by submitting a Self Assessment tax return to HMRC.

For limited companies, there are additional requirements. You need to submit a Company Tax Return for the business and file accounts with Companies House. You will also need to report any personal income from the company, such as dividends, by submitting a Self Assessment tax return.

Comprehensive tax return services are available starting from £24.50 per month.

Registering your new business The registration process differs depending on whether you choose to become a sole trader or operate as a limited company.

Registering as a sole trader: Sole traders register by signing up for Self Assessment with HMRC. The deadline for sole traders to register for Self Assessment is the 5th of October in the business’s second tax year.

Incorporating a limited company: Establishing a limited company involves a slightly different process. You need to register the company with Companies House, which will automatically enroll you for Corporation Tax with HMRC.

Setting up a limited company requires additional paperwork, such as appointing directors and shareholders, and preparing documents outlining how the company will operate. Unlike sole trader businesses, there is a fee associated with registering a limited company.

Limited company registration services are available, and we can incorporate your company for free.

Choosing the right legal structure for your new business The decision on how to structure your business ultimately depends on your individual circumstances. However, there are a few points to consider:

  • Is your projected profit around £30,000 or higher?
  • Does your business entail high-risk factors in terms of liability, such as extensive public interaction or large transactions?
  • Do you have income from another job?

While not definitive, answering “yes” to any of these questions may indicate that registering as a limited company could be more advantageous than becoming a sole trader. However, it’s essential to remember that each situation is unique, so seeking advice before making a decision is recommended.

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