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When Should Sole Traders Set Up a Limited Company?


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Working as a sole trader or owning a limited company are two very different business structures. Both have their advantages and disadvantages, and you should choose the one that better fits your business. However, there comes a time when sole traders should consider changing their operating structure and set up a limited company.

As contractor accountants, we can help you to choose the right moment to switch and to understand how your business will change.

What Are the Benefits of Setting Up a Limited Company?

Becoming the director of your own company comes with more admin and paperwork – however, the advantages this operating structure offers are more than worth it. Incorporating your business is more tax-efficient and offers limited liability, which means your personal assets are not at risk in case something happens.

In addition, becoming a limited company can make you more credible among potential clients, especially larger businesses, and you’ll have more borrowing power should you require it.

Your personal income will be a combination of salary and dividends, which are taken from the profits of the company after you pay corporation tax.

When you’re a sole trader, you pay tax on your income via your self-assessment. Depending on how much you earn, you could be paying a high percentage of Income Tax and National Insurance contributions. As a limited company, the main rate of corporation tax in the present tax year is 19%, so you may not pay as much. In April 2020, this rate is set to decrease to 17%.

When Should You Switch to a Limited Company?

A lot of businesses start as a sole proprietorship but eventually become limited companies. Seeing as there’s more personal responsibility on sole traders in regard to tax and loss, owning a limited company may be the best option for contractors to grow their business. It can be difficult to know when the best time is to transition to a new business structure, so the best way to go about it to engage the services of a specialist accountant that can give you advice.

As both sole trader accountants and limited company accountants, we’re well aware of the pros and cons of each business structure, as well as when is the best time to switch.

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When You Increase Your Earnings

You may want to start looking into incorporating your business when you start making more money. Consider the profit you’re making and the current rates of tax you’ll have to pay, which will help you to make the decision. In addition, if your earnings are low, the better option is to remain as a sole trader, since your accounting responsibilities will be simple.

Some contractors choose to set up a limited company when they start making over £30,000, for example, while others wait until they’re making more than £50,000 – there is no exact number that can give you absolute certainty it’s time to switch. Instead, it depends on your sector, on the work that you do and where you wish to take your business in the future.

When You Want to Change Your Clients’ Perception of Your Business

Reputation and brand image are crucial in business. As a sole trader, and in the eyes of some clients, you won’t have the same authority as a company. Retailers and even suppliers may prefer to deal with a company than with an individual, so incorporating can offer you more opportunities. If you’re seeking investment in your business, being a limited company will increase your chances of success.

When You Want to Claim Tax Relief on Business Expenses

As a limited company, you have to pay corporation tax on any profits that you make before taking dividends from your business. However, you’re able to claim expenses that you couldn’t as a sole trader, which will bring down the profit and, therefore, the tax you’re due.

In addition, limited companies are more tax-efficient in general. Sole traders have to pay income tax on profits as well as Class 2 and Class 4 National Insurance contributions but, by incorporating, you’ll only pay corporation tax, which is set at a lower rate than income tax. Of course, sole traders do have a personal allowance before having to pay taxes, which is currently £12,500.

When You’re Considering Bringing in More People

Businesses change over time so, depending on the direction you wish to take your business, you may want to bring in shareholders or other directors. If this is the case, then you will need to become a limited company. You can pass on ownership of your limited company to someone else as well, since your company would be a separate legal entity which will continue to exist even if you’re not there anymore.

When You Want to Protect Your Business Name

Once you form a limited company and register it with Companies House, no other company can use the name you’ve registered, which means you will secure it for the future. This will give you the peace of mind of knowing that no one else can take your name and use it as they wish – in addition, they won’t be able to use a very similar name as well, which is handy if you want to get your brand out there.

When You Want to Limit Your Liability

As we mentioned before, forming a limited company will ensure you’re protected in case something goes wrong. As a sole trader, you’d be personally liable for debts that your business incurs – as a limited company owner, you have this extra layer of security that sole traders don’t have. This is especially important if you work in a high-risk industry or are taking risks in your business.

So, while it is not mandatory, we advised that, when you change to a limited company, you also create a separate bank account to keep your company’s finances split from your personal ones.

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When You Want to Increase Your Borrowing Power

Limited companies can establish their own credit rating, which can be helpful if you’re looking to borrow money to invest. The same doesn’t happen if you operate as a sole trader – in a sole proprietorship, individuals have to rely on personal credit ratings, which may not be enough to be approved for loans, for example.

When You’re Looking to Expand

As a sole trader, your business is a one-person show. If you want room to grow and are looking to expand your business, becoming a limited company will give you the options you seek. After all, you can hire employees and add them to your PAYE scheme, you can sell shares, you can consider taking on investments, and more. You can even become a partnership if you believe that is the best direction for your company.

In addition, you have the opportunity to sell your company if you wish, which can give you a considerable amount of money if you become very successful.

When You Want to Get a Mortgage

It may be easier to get a mortgage if you’re the director of a limited company instead of a sole trader, as some banks look at that type of structure more favourably. This is not always the case, so you shouldn’t let this become the only deciding factor in your decision to incorporate, although it’s something to keep in mind.

How to Go from Sole Trader to Limited Company Director

The process to form a limited company can be a deterrent for a lot of self-employed individuals, as it’s more complex than registering as a sole trader and involves a lot more paperwork. However, if you decide this is the right type of business structure, it is more than worth it.

You will have to decide if you’re going to be the only director of the company or if you’ll bring in other people. You will also have to tell HMRC that you’re changing the legal structure of your business, since this will change your tax payments. Should you decide to close or sell your company, you will have to notify HMRC as well. After you choose the name for your limited company, you will have to register at Companies House.

Of course, set up a business bank account and, if you already have insurance, let them know your business is now a limited company.

If you purchased business assets as a sole trader, you have the chance to move them to your company when you set it up. There may be tax or legal responsibilities to this, so seek professional advice before you make the transfer.

And, if you’re unsure about the process, don’t have the time to spare or are worried about making a mistake, Gorilla Accounting is here to help. We can help you to set up your limited company in no time, allowing you to start enjoying the benefits this operating structure offers.

Should You Remain a Sole Trader?

While there is no denying the advantages that forming a limited company offers, it’s also important to note that operating as a sole trader may be the better option for you – at least temporarily. There is nothing to stop you from setting up a limited company in the future so don’t rush into any decision.

Changing to a limited company will carry extra responsibilities that not all sole traders may be ready for, so you may want to take them into consideration before making a decision. For instance, you will have to submit your financial records to Companies House every year, will have the obligation to get PAYE set up and will have to manage your company’s finances.

In addition, you may not want to switch structure if your earnings are still relatively low. The added bonus is that your finances will be simpler, as being the director of your own limited company means more documentation to fill out.

Another thing to consider is that, as a sole trader, your business is private, and you don’t need to share data with anyone. Limited companies, on the other hand, need to publish certain information, from names of directors to annual finances, all of which can be found at Companies House.

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We have been providing accounting for contractors for many years, so we can help you to make the right decision for you. If you’re ready to incorporate your business, don’t get caught up in the things you need to do to become a limited company or in the paperwork you have to fill out – let us take care of it while you focus on your business.

You’ll have your very own dedicated accountant on hand to help you with everything you need, be it during the formation process or when it’s time to submit your corporate tax. The financial, legal and trade benefits that come from being a limited company are worth it, so contact the Gorilla Accounting team and we’ll be more than happy to help.

In the meantime, why not check out our contractor tax calculator to figure out your take-home pay?


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