Sole Trader or Limited Company: Which one best suits you?

The two best business structures for self-employed people are a sole trade or a limited company. They have different aspects regarding tax payments, accounting reporting restrictions, and financial risks.

So before electing any specific business criteria as a self-employed person, learn these business structures properly to make informed choices. With a better understanding, you can select the right fit business that perfectly aligns with your goals.

This article will comprehensively guide you through the differences between sole traders and limited companies and their benefits and disadvantages for self-employed people.

Browse through the sections by clicking on the titles below.

• What is meant by a sole trader?
• What is meant by a Limited Company?
• Sole Traders Compared to Limited Companies: What are the Key Factors
• How Does IR35 Affect This?
• Perk of Working With an Accountant

What is meant by a sole trader?

The sole trader owns the simplest business structure, which is also called personal ownership. They own and run their own business. Also, there’s no legal distinction between the business holder and the business, which means there is no financial risk. 

Sole traders are personally responsible for paying debts incurred by their business, which means they are responsible for their home, car, or investment. They can also pay their taxes via self-assessment. They must make an annual tax return and are responsible for paying income tax on business profit after the permitted expenses have been deducted, depending on which tax band their earnings are in. 

                              Basic          →               20%

                             Higher       →               40%

                            Average      →               45%

Sole traders are also responsible for paying class 4 and class 2 National Insurance contributions. However, class 2 National Insurance will be revoked from April 2023/24. Annual self-assessment of administrative and reporting obligations is low for sole traders as they are not monitored regularly for limited companies. As sole traders, annual accounts don’t need to be filled with companies’ houses; they also get relief over corporation tax. The reduced burden of taxes is the key attraction of the business structure, which involves a simpler process to set up the company.

What is meant by a Limited Company?

A private limited company is a business structure that completely separates its legal entity from its owners. This allows the owner to benefit from less financial exposure due to limited liability. Because the business is a separate entity from the business owners, the liability is limited to the amount invested in the industry, which helps prevent assets from creditors.

Limited companies can face trouble with taxation, but they also have significant benefits from a tax perspective. They should be filed for corporation tax and must pay annual corporation tax to HMRC on profits. Income tax should be paid through salary, but remuneration tax can be paid by splitting salary and dividends.

Administration and bookkeeping requirements are more comprehensive for limited companies. Legal processing for registration must be maintained, and annual accounts must be filed with Company House. Company laws must be followed, and yearly meetings are required.

Sole Traders Compared to Limited Companies: What are the Key Factors

• The Financial Risk You Can Encounter

Assessing the financial risk associated with your work is imperative. If you have a more significant investment or earn a principal amount of money, then the financial security offered by a limited company could be the best choice. Another factor is to consider your confidence in your success. If you are passionate and confident, you will thrive and surely achieve success. Moreover, your business will earn a substantial profit, and liabilities won’t be a significant concern. It is always the best way to remove relevant contractor insurance, such as professional indemnity cover, to remove the risks. This, in turn, will protect you from penalties.

• Your Administrative Capabilities

You should take stock of work for admin tasks. This is especially beneficial for startups where you must spend much time building your business. Record keeping and admin tasks are much less demanding for sole traders. However, limited companies must ensure a pile of work for admin tasks. Also, it is difficult to ensure compliance with tax laws. 

• Your Objectives

If you aim to grow and scale up your business over the long term, a limited company is the proper structure for you. With a limited company, you will find it very simple to access capital and investment to fund your business growth. This is because lenders and investors see limited companies as less risky investments.

Limited companies also get favour from clients due to the company’s impression of stability and professionalism. Also, limited companies show more transparency and tighter regulations. So, all these pros help you gain more work than a sole trader does.

• Your Tax-Optimisation

A limited company is an apparent tax-efficient option. As the director of a limited company, you can structure your payments between salary and dividends. Dividends are company profits after taxation and are taxed lower than income tax on salary. This means that with the proper structuring of income tax, savings can be made, and your take-home pay can be increased while staying compliant.

How Does IR35 Affect This?

It’s well known that as a self-employed person, the scenario should be outside IR35 and operate through your limited company. But what should you do if you operate a limited company inside IR35? Or Would you like to be a sole trader if IR35 doesn’t apply?

Contracting via a limited company inside IR35 can be a worse choice than operating as a sole trader. Your taxes will be deducted from the source through pay as you earn. However, as a limited company inside IR35, you would have to pay a corporation tax, on which sole traders get relief. So, as a sole trader, you can earn more. However, everyone has different prospects regarding businesses, which gives them trouble choosing any specified field. Here comes our accountant at your service and a free consultation.

Perk of Working With an Accountant

Every business owner or self-employed person makes different choices and decisions. So, what is best for you depends on your long-term goals and aspirations. Every structure, whether limited company or sole trader, has advantages and disadvantages, requiring clear thinking and a sharp mind. So, working with an expert accountant is always best for whichever business you elect. 

At Lockhart Amin, our experts can handle all your concerns and provide exceptional advice to help you focus entirely on your business. We ensure your peace of mind by handling your accounting and tax obligations. If you want the best business advice or know more about our accounting services, call us now.