Setting up your own business is an exciting venture and there are many tasks to complete in the initial stages – choosing a business name, designing your branding and building your social media presence. One of the most important decisions that often gets overlooked is the structure in which your business should operate. Today, we’ll be diving into the pros and cons of operating as a sole trader vs a limited company, so you can make the most informed decision.
Sole Trader: The Simplest Option
What is a Sole Trader?
A sole trader is an individual who owns and operates a business. There’s no legal distinction between the business and the person – you and your business are effectively one and the same. Let’s talk pros and cons…
The Pros:
Easy to Set Up: Starting as a sole trader is a straightforward process. Registering as self-employed with HMRC is all it takes – no complex paperwork or formalities.
Privacy: As a sole trader, you’re not required to publish your earnings or financial performance publicly. This means more privacy, which is ideal for people that prefer to keep financial details under wraps.
Lower Admin Costs: Registering as self-employed with HMRC is completely free. Plus, managing taxes and accounts is simpler and cheaper than running a limited company, often resulting in lower accountancy costs.
The Cons:
Personal Risk: The biggest downside to being a sole trader is that you’re personally liable for the business. Because there is no legal distinction between yourself and the business, if you were to run into any financial difficulties or debt, your personal assets could be at risk. This is known as ‘unlimited liability’.
Tax Inefficiency: As your profits grow, you’ll find that being a sole trader becomes tax inefficient. Sole traders pay tax starting from 20%, plus national insurance. This jumps to 40% for those reaching the £50k profit mark.
Rigorous Record-Keeping: Despite the simplicity, you’ll still need to keep your accounting records meticulous and comply with HMRC standards. Neglecting this could lead to some serious penalties.
Limited Company: Protecting Yourself and Saving on Taxes
What is a Limited Company?
A limited company is a separate legal entity from its owner(s), meaning that it has its own legal identity. Limited companies can have one or more owners – these are called ‘shareholders’.
The Pros:
Less Risk: With a limited company, the business is considered its own person in law. This means your personal assets are protected, and your financial risk is limited to the amount you have invested into the business.
Tax Savings: Limited companies benefit from lower tax rates (between 19-25%). As a sole trader, you’ll pay tax at 40% once you reach £50k of profits each year, so forming a limited company can offer much more advantageous tax rates.
Enhanced Remuneration: Added to this, dividends are taxed at a lower rate (starting from 8.75%) and are exempt from national insurance, allowing you to take home more of your earnings.
The Cons:
Less Privacy: Unlike sole traders, limited companies must file annual accounts with Companies House. These accounts, along with directors’ details, are publicly accessible, which could be a consideration for businesses that value privacy (that being said, we’ll always make sure the info shared online is as brief as possible!).
More Admin Work: Running a limited company comes with more regulatory requirements, from filing annual accounts to submitting corporation tax returns. This means more paperwork and legal filings, which can be a strain if you are doing the work yourself.
Higher Accountancy Costs: Given the complexity of managing a limited company, you’ll likely need an accountant. While this incurs extra costs, more often than not the benefits outweigh the costs as a good accountant can help save you more money through efficient tax planning.
So, Which Is Right for You?
The choice between a sole trader and a limited company depends on several factors. Here are a few questions to ask yourself:
What’s your risk tolerance? If you’re worried about personal liability, a limited company might be the better choice.
Is the business a side hustle? If your business is something you do alongside your full time job, operating as a sole trader may be better for you due to the ease of setting up and fewer compliance requirements.
How much do you plan to earn? If your business is set to scale quickly, the tax benefits of a limited company may become more advantageous.
By structuring your business the right way, you can improve not just your financial situation, but also your communication processes with partners, clients, and stakeholders.
Still unsure which structure fits your needs? Reach out to our team at Mystyle FInance where we can provide you with a tailored consultation, offering a no-obligation quote and tax comparison to help you make the most informed decision based on your unique circumstances.
