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Sole Trader Versus Limited Company: Making the Right Business Structure Choice


man and woman discussing business structure

Sole Trader versus Limited Company? This is a question that every sole trader will ask themselves at least once, if not multiple times over the course of their business ownership.


The decision to run your business as a sole trader or limited company will depend on your own personal circumstances and will be based upon multiple factors. Here are just some of the factors to consider when making the decision of whether to go limited or stay as a sole trader.


Tax

As a sole trader you submit a self-assessment tax return from which HMRC calculates your tax to pay and you make payments by January 31st and payments on account by July 31st. The tax you pay is based on the profits you have made; the profits remaining after tax are yours to use as you wish.


As a limited company you also pay tax on your profits - this is known as corporation tax which is currently (2022/23 tax year) taxed at the rate of 19%. Unlike self-assessments, there isn’t a fixed date by which every limited company has to pay their corporation tax. Instead, companies have 9 months and 1 day after their year end to pay their corporation tax.


Paying yourself

Having paid corporation tax, you're one step closer to getting your hands on your business profits. As the shareholder of the limited business, any profits after tax belong to you, the shareholder.


The profits of the business are paid to shareholders in the form of dividends. You can earn £2,000 in dividends tax free each year, after which you pay tax, currently at the rate of 8.75% for lower rate taxpayers and 33.75% for higher rate taxpayers.

The dividends you receive and the subsequent tax payable is recorded via self-assessment. You've not escaped self-assessments altogether by choosing a limited company structure!


The other way to pay yourself is through payroll. Because the limited company is a separate legal entity, you can be both a shareholder of the business and a director/employee of the business.


Unlike being a sole trader, or taking dividends, paying yourself through payroll is a legitimate business expense which in turn will reduce your profit, which in turn again will lower the amount of corporation tax you have to pay.


However, paying yourself through payroll in your limited company can give rise to both income tax and national insurance deductions for you personally, as a director/employee of the business and also the company may have to pay employers national insurance on the amount paid to you. Remember, in this situation, you should consider yourself both the employer and the employee because at the end of the day whether it's you personally paying out or your limited company, ultimately, it's all your money.


You can choose to pay yourself in part through payroll and part in dividends, you don’t have to choose one or the other, but remember that dividends can only be paid up to the level of your cumulative post-tax profits over the years minus any dividends you’ve already received.


While you have to pay corporation tax when it’s due, you can choose when to pay yourself dividends which can be an important consideration especially when you draw close to the end of a tax year. You may want to defer a payment of dividends if you’ve already earned a lot in the year and any future dividends within the tax year could push you into the higher rate tax band.


Legal status

In the eyes of the law a limited company is considered a separate legal entity. Unlike a sole trader where you and your business are one and the same thing, a limited company is legally separate from you. Your relationship with a limited company is likely to be two-fold. Firstly as the business owner, your ownership of the business is distinguished by owning shares in the business. Secondly, as a director and employee of the company.


Liability

A limited company is so named limited, because it offers limited liability to its shareholders. So what does this mean in real terms?


As a sole trader, if your business were to fail for whatever reason and you were unable to pay your debts, then your suppliers, lenders or anyone else you owe money to could come after your personal assets, for example in extreme circumstances, you could be forced to sell your house if you owed a large amount and had no other means to pay it.


As a limited company, the buck stops with the company in most cases. If it were to fail and there was no more cash or assets to sell to pay off its lenders, the company would fold and that would be the end of it.


There are still circumstances when you could still be pursued personally, such as trading when you know you can't pay your suppliers.


In general, limited companies can offer a relative safeguard should the worst happen, but whether this is an important consideration for you and your business is very much dependent upon what you do and what you have planned for the future of your business.


Compliance

As a limited company you'll be required to submit annual accounts to Companies House and a Corporation Tax return to HMRC each year.


You'll also need to file a Confirmation Statement each year to confirm your company details are correct or to make any changes as appropriate.


For the most part, running a limited company is likely to be more expensive in terms of accountancy fees than running your business as a sole trader. However, these fees needn't be excessively higher but there is generally more work to be done on your business compliance.


Banking

Being a separate legal entity, you must have a separate bank account. The bank account is not in your name, but in your company’s name.


Nowadays, with challenger banks such as Starling Bank, you can open a business bank account quickly and easily and without any of the usual fees you'd expect from a high street bank.


Whether you have a limited company or are a sole trader, it's really good practice to separate your business banking from everything else to keep a clear view of your business finances.


Summary

If you're a Sole Trader in or around Leamington Spa and you're wondering whether moving to a limited company structure is right for your business then get in touch with us to arrange a free discovery call by using the contact form on the website or e-mailing info@duoaccountants.co.uk.


We can discuss with you your current circumstances and plans for the future and help you in deciding which structure is best for you.

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