Should I set-up as a sole trader or limited company?
Which is right for you will depend on your business goals and personal circumstances. Our aim with this article is to help you understand the differences and help you to make an informed choice.
We get asked this question not just by clients at the start of their business journey, but also by those thinking about a change in setup. This is because both structures have their own advantages and implications, especially when it comes to management, tax and personal liability.
The difference between being a sole trader and a limited company
The fundamental difference between a sole trader and a limited company revolves around the legal and financial separation between the business and you, its owner.
Sole trader
As a sole trader, you are the business. This means there's no distinction between your personal and business finances. You have full control over your business and you can keep all the profits after tax.
However, it also means you’re personally responsible for any losses, which can put your personal assets at risk if you can’t repay the debts you have to suppliers or lenders.
Limited company
In contrast, a limited company is a separate legal entity. Shareholders own it and directors run it. If it’s just you, you’re the sole shareholder and company director.
This structure means the company's finances are distinct from your personal finances and the finances of any other directors. Shareholders are only liable to the extent of their investment, and directors are not personally responsible for the debts of the business, unless there’s evidence of misconduct.
The tax benefits of being a sole trader or a limited company
The fundamental difference between a sole trader and a limited company revolves around the legal and financial separation between the business and you, its owner.
Sole trader
As a sole trader, you are the business. This means there's no distinction between your personal and business finances. You have full control over your business and you can keep all the profits after tax.
However, it also means you’re personally responsible for any losses, which can put your personal assets at risk if you can’t repay the debts you have to suppliers or lenders.
Limited company
In contrast, a limited company is a separate legal entity. Shareholders own it and directors run it. If it’s just you, you’re the sole shareholder and company director.
This structure means the company's finances are distinct from your personal finances and the finances of any other directors. Shareholders are only liable to the extent of their investment, and directors are not personally responsible for the debts of the business, unless there’s evidence of misconduct.
The tax benefits of being a sole trader or a limited company
Sole Trader:
Being a sole trader makes managing your tax simpler. There's less paperwork and so lower accounting costs.
You’ll pay Income Tax on your business profits through a Self Assessment tax return and National Insurance Contributions (NICs) also apply.
However, as your income increases, the tax rate can become unfavourable compared to a limited company, especially if your profits exceed the higher income tax threshold.
Limited company
Unlike sole traders, limited companies pay Corporation Tax on their profits. However, historically this has been lower than the higher Income Tax rates.
After paying Corporation Tax, your company can distribute the remaining profits as dividends to shareholders, who then may pay less tax overall compared to a sole trader on the same level of income. You might also choose to retain some of profits in the company for reinvestment.
The protections offered by being a sole trader or a limited company
Sole trader
As we’ve mentioned above, as a sole trader you have personal liability for your debts. This means that creditors can claim against your personal assets if your business struggles financially.
To counter this, you can take out insurance, like professional indemnity insurance, to protect yourself financially. But, overall, the personal risk is higher than in limited company.
Limited company
A limited company gives you the protection of 'limited liability'. Should the company face financial difficulties, the personal financial risk to shareholders is limited to their share investment. As a company director, your personal assets are typically protected.
This protection gives many business owners peace of mind, especially when they’re starting out on a new, untested venture.
Every situation is unique, making it essential to seek professional advice tailored to your specific circumstances. We can help with that, and many of the other choices you have to make as a business owner.