Sole Trader vs Limited Company: Which is Right For You?

The two most common business structures for self-employed people are sole trader and limited company. They both have different implications on many areas of your business including your accounting and reporting obligations, the amount of tax you’ll pay and the level of financial risk you’ll face.

It’s crucial therefore that anybody intending to move into self-employment understands these business structures and their advantages and disadvantages in order to make an informed decision on which is the right fit for their circumstances and goals.

It’s possible also that you might have been working for some time as a sole trader and having established and grown your business you’re considering incorporating and trading through your own limited company.

As expert accountants for self-employed professionals and small businesses, we have accounting packages tailored for sole traders and limited companies operating across a wide range of sectors and can also offer expert advice on which is the best business structure for you.

In this post we’ll take a dive into the sole trader vs limited company waters and give you the lowdown on each, including their advantages and disadvantages.

What is a Sole Trader?

Sole Trader is the simplest form of business structure. Also known as sole proprietorship or personal ownership, sole traders personally own and run their entire business. There is no legal distinction between the owner and the business itself which affects the level of financial risk sole traders face.

Due to unlimited liability, sole traders are personally responsible for any debts incurred by their business should it run into financial difficulties or become insolvent. This means that potential liability is in theory unlimited and due to sole traders being personally responsible for business debt, the owners’ personal assets such as their home, car or investments could be pursued by creditors.

Sole traders pay their taxes through self-assessment. An annual self-assessment tax return must be completed and they are responsible for paying income tax on company profits after allowable expenses are deducted at the basic (20%), higher (40%) or additional (45%) rates depending on which tax band your taxable profits are in. They also pay Class 4 and, currently, Class 2 National Insurance Contributions but Class 2 NICs will be abolished effective from the start of the 2023/24 tax year.

Administrative and reporting obligations are relatively low for sole traders as they’re not as rigorously monitored as limited companies. As such, annual accounts don’t need to be filed with Companies House and they don’t have to pay Corporation Tax. The reduced admin burden is one of the key attractions of this business structure, and this includes a simpler process to get the company set up.

What is a Limited Company?

A private limited company is a type of business structure that’s a completely separate legal entity from its owner or owners. Due to this, the owner benefits from reduced financial exposure thanks to limited liability. Because the business is a legally separate entity from the business owner, should it incur debt the liability of the owners is limited to the amount they have invested in the business which helps to safeguard their personal assets from creditors

The landscape is more complicated for limited companies when it comes to taxation, but there are significant advantages from a tax perspective. An annual Corporation Tax return must be filed with HMRC and Corporation Tax must be paid on company profits. Income tax must be paid on salary but  remuneration can be split between a combination of salary and dividends. This has tax implications in that it increases complexity but due to tax rates being lower on dividends, it can also increase take home pay with the right structuring.

Administration and bookkeeping requirements are more extensive for limited companies. A statutory register must be maintained, annual accounts must be filed with Companies House, company law regulations must be adhered to and annual general meetings are required.

Sole Trader vs Limited Company: Key Factors to Consider

The Financial Risk You’ll Face

It’s important to carefully assess the level of financial risk associated with your work. If the nature of your work involves large sums of money then the financial protection offered by a limited company would make that the best choice.

Another factor to consider is how confident you are of success. If you’re confident your business will thrive and turn a good profit then unlimited liability wouldn’t be a significant concern.

It’s always a good idea to take out relevant Contractor insurance such as Professional Indemnity cover to mitigate these risks and protect both your business and yourself from potential liabilities.

Your Capacity For Admin

You should take stock of the capacity you think you’ll have to put into admin tasks. This is especially the case for new startups where you’ll need to put a lot of time into building your business. Record-keeping and admin tasks are much less onerous for sole traders whereas limited companies face a relatively significant amount of admin work and it’s also harder to ensure compliance with your tax obligations.

Your Ambition

If you have ambitions to grow and scale your business over the long term, limited company is the right structure for you. With a limited company you’ll find it much easier to access capital and investment to fund business growth as lenders and investors view limited companies as being less of a risk. Limited companies are also looked on more favourably by clients and potential clients as they give an impression of stability and professionalism as well as more transparency and tighter regulation all of which can help you secure more work than if you were a sole trader.

Your Tax-Efficiency

Limited company is the obvious choice from a tax-efficiency standpoint. As the director of your own limited company you can structure your remuneration between a combination of salary and dividends. Dividends are company profits after tax and are taxed at a lower rate than income tax on salary which means that with the right structuring of your income, tax savings can be made which can increase your take home pay while remaining compliant. You’re also able to claim a wider range of allowable expenses which can reduce your overall tax liability.

What about IR35?

It’s well known that as a self-employed person the ideal scenario is to be outside IR35 and operating through your own limited company. But should you operate through a limited company if you’re inside IR35, or would you be better off as a sole trader where IR35 doesn’t apply?

As a general rule, contracting through a limited company inside IR35 can be a worse option than operating as a sole trader. Your taxes will be deducted at source through Pay As You Earn (PAYE) either way, but with a limited company inside IR35 you will also have to pay Corporation Tax which sole traders aren’t liable for, so you can potentially earn more as a sole trader in this scenario. Of course everyone’s circumstances are different and there are many factors to consider and our expert accountants are on hand to advise you should you have any queries.

The Benefits of Working With an Accountant

Everyone’s circumstances are different and the same is true for every business and the decision of what business structure is right for you must be based on those circumstances and your long-term goals and aspirations. Each structure has its own pros and cons and it is, of course, a big decision that requires research and careful consideration. But you’re not tied to a business structure forever and many self-employed people will start out as sole traders and incorporate further down the line.

Whichever business structure you choose, it’s always a good idea to work with an accountant. As expert accountants for both sole traders and limited companies, we can offer you advice on the best business structure for you. Our accounting packages mean that all your business and personal accounting needs will be expertly handled by your own dedicated accountant allowing you to fully focus on your work with peace of mind that your accounting and tax obligations are in hand.

With Gorilla you’ll receive unlimited support, advice and guidance and a same working day response to your queries thanks to our Client Service Guarantee. Market-leading FreeAgent accounting software is also included free of charge for all our clients.

If you’re already operating as a sole trader but are thinking about setting up a limited company, our company formation service takes care of the whole incorporation process for you and we can usually have your limited company set up the same day.

If you’re looking for advice on the best business structure for you or would like to enquire about our accounting service, speak to an accountant today on 0330 024 0406 or request a callback.