If you’re about to go self-employed, you’ll quickly find yourself facing an important choice: do you run your business as a sole trader or as a limited company?

With each option brimming with advantages and disadvantages, both structures benefit certain businesses more than others and honestly, it’s hard for any accountant to advise on this issue without knowing your specific situation.

We’ll get back to that, but a good place to start is with the key features of  sole traders and limited companies to give you an idea of why you might want to choose one over the other.

Difference between sole traders and limited companies

As the name suggests, a sole trader is solely responsible for their business, its successes and failures.

Legally, you and the business are one and the same. What the business owns, the sole trader owns. What it earns, they earn. And what the business owes its creditors, they owe.

When it comes to the name ‘limited company’, on the other hand it’s not that the company is limited in what it can do, but that your personal liability from it is limited.

In practical terms, that means you and the company are two separate legal entities, unlike a sole trader and their business. It’s a subtle difference with huge ramifications that we’ll discuss in a moment.

Both sole traders and limited companies can either hire employees or operate without any, and can come in a range of shapes and sizes. Indeed, it’s not uncommon for a sole trader to be larger than a limited company.

Sole trader pros and cons

The ease and simplicity of being a sole trader attracts many business owners to this structure, especially startups. There’s less paperwork, fewer registrations, only one tax return to be filled out each year (personal income tax self-assessment), and no registration fees.

The tax situation is manageable for some sole traders, too. Profits are taxed through income tax, which you can then split between your business and your personal costs, while you can reclaim allowable expenses for various running costs incurred in a tax year before we work out your taxable profit. 

With the basic rate of income tax (20%) being just above the main rate of corporation tax (19%) in 2021/22, there’s not much to be lost in the way of tax compared to limited companies. 

If your business’s income enters the higher and additional-rate bands of income tax, however, taxed at 40% and 45% respectively, you might have to cough up considerably more.

Moreover, as you and the business are legally one and the same, if it gets into trouble, your personal assets could be on the line, including your home, if you don’t pay your creditors. 

If the business goes bust, you could then face personal bankruptcy and all the restrictions that brings.

Limited company pros and cons

The lack of separation between sole traders and their business, and the problems that can bring don’t apply to those running a limited company because of their limited liability from it.

This protective barrier means, for example, that if your company can’t pay its debts, you won’t be personally liable to pay them, so your personal assets will be completely safe.

Owning a limited company can also be more beneficial for your personal tax planning than being a sole trader. 

Many company directors pay themselves a modest salary under the Class 1 National Insurance threshold, currently £8,840, so they don’t have to pay income tax or employer’s National Insurance. They can then top up their earnings with dividends, which are taxed at lower rates than income tax. The result: they can keep more of their personal pay cheque than sole traders.

All of your company’s profits will be taxed at a flat rate of 19% through corporation tax, significantly lower than the 40% or 45% you might pay as a successful sole trader.

Limited companies, however, can be difficult to manage if you undertake the tasks involved on your own as they come with a range of statutory obligations.

For instance, you’ll need to register your company with Companies House and HMRC, and submit a corporation tax return each year on top of your personal return.

You’ll also have to put all of your personal information (name, address, date of birth and so on) out there for the world to see, although our company secretarial service offers you the chance to use our address as your registered office if you wish to keep some of your details out of the public domain.

Using this information, you may be able to decide if you want to run your business as a sole trader or limited company. But reach out to us for more advice tailored to your circumstances.

We can also run the numbers to make sure your business is as tax-efficient as possible.

Talk to us about your business structure.