Should you register as a sole trader or a limited company?

Starting with a sole trader or even a limited company, the future structure and legal status of your business is a critical concern.

Every facet of your organisation, from taxes to revenues to what happens if your firm runs into financial difficulties, may be impacted by the structure you pick. What may work for a company may not work well for another. As a result, you must balance the advantages and disadvantages of each option to arrive at an educated conclusion.

Sole traders and limited companies each have their benefits and drawbacks, and I’ll explain them in detail so that you can make an informed decision about which business structure is best for your startup. Learn more by reading on.

The fundamental differences between sole traders and limited companies

A sole trader is a self-employed person with full ownership of their business: it does not have a separate legal identity from that of the owner. That means that a sole trader takes full liability. To become a sole trader, you must register using the government portal within three months of founding your business.

A limited liability company is one which is legally distinct from the identity of the owner. It has a unique company identity, which must be registered (for a small fee) with Companies House. Because of this, there may be more than one owner or director, and they will have limited liability — meaning their personal finances won’t be affected should the business struggle financially.

Sole trading vs limited companies: Which is right for your business?

The sole proprietorship has certain financial benefits for small firms and self-employed craftsmen, but it also comes with a higher risk. A limited liability corporation (LLC) may insulate the owners from these dangers by granting them limited responsibility. Still, it can also need many administrative and fiduciary tasks for the directors.

The advantages and disadvantages of both models will be discussed in this part, including the potential for earnings, tax efficiency, and liabilities.

Earnings

The self-assessment tax system allows sole proprietors to retain 100% of their profits. As a result, your income is dependent on how well you do in any given year. This means that although enormous gains are possible, there is also the danger that you will not generate enough money to earn a respectable income.

Limited firm owners get a salary and pay tax at the usual PAYE rate on that wage. Depending on their overall success, they may also be eligible for bonuses and dividends to supplement their salaries. A fall in the tax-free allowed for dividends (from £5,000 in 2017 down to £2,000 in 2021) has hurt the tax-free incomes of limited company directors during the previous several years.

Tax

For limited corporations to pay corporation tax, they must be registered with Companies House. To put it simply: Corporation tax is lower for large organisations, making it a considerably more tax-efficient model for businesses with substantial turnovers and big profits.

Corporation tax is not required of single proprietors, as it is for limited corporations. Solopreneurs have to pay income tax at the ordinary rate and National Insurance payments on all earnings: these are set at Class 2 for profits of £6,515 or more (for the tax year 2021/22), and Class 4 for profits of more than £9,568 (for the tax year 2021/22) for sole businesses. To avoid paying taxes, you may deduct all of your company expenditures. You may get all the information you need about National Insurance contributions at this link: (.gov. uk)

Smaller merchants with lesser earnings may benefit from this kind of tax, while those who make more than £25,000 may find it inefficient. If your income rises to a certain level, you may find it more tax effective to set up a limited business and pay yourself a salary.

HMRC requires self-employed individuals to file tax returns and register as self-employed, although their tax responsibilities are much less complicated than those of corporations.

Consequently, they may be held responsible for any fines or penalties that occur from late returns or mistakes in their documentation since they have complete responsibility.

Take a look at TRUiC’s S Corp tax calculator, something that can help you decide if your business should elect S Corp status or not.

Responsibilities and personal liability

Being a single proprietor gives you the entire control over your firm, as well as the benefit of dealing with less paperwork, but at the expense of more personal exposure.

Debt collectors in the UK have the power to seize your assets (including your home) to pay off your obligations since there is no legal difference between your assets and those of the corporation. Clients or customers who sue or go to court against you may be forced to foot the bill.

Directors of a limited company are unlikely to be held liable for the firm’s debts or litigation because of the limited liability (with the possible exception of criminal activity or negligence). Unlike a single proprietor, the directors of a limited company are shielded from bankruptcy, even if the firm goes bankrupt: their assets will be preserved.

As a result, single proprietors must acquire professional indemnity or public liability insurance to safeguard themselves. Consider the cost of these policies before deciding: it may be a case of determining whether the convenience of solitary trading is worth the higher risk and insurance expenses.

Summary

Whether you choose to form a sole proprietorship or a limited liability corporation has a lot to do with the kind of business you want to run.

Solo traders may favour the simplicity and control over revenues that sole trading provides, while individuals who want to form a big firm with many workers may prefer the protection that registering as an LLC provides, especially liability. It all comes down to your company strategy and long-term ambitions.

Limited Company or Sole Trader – Key comparisons