Sole trader or limited company: It’s a question that faces many new business owners and even freelancers considering their options. Which of these is the right one for you? As a sole trader, you don’t have to file anything with Companies House, but you also face stricter personal liability if anything goes wrong. As a limited company, your personal liability is limited, and there are other benefits, but you need to register with Companies House and file annual accounts. So which is best for you? Here’s everything you need to know…
What is a sole trader?
A sole trader is an individual who runs a business under their own name but without any form of company structure. It’s a very straightforward business setup without any legal structures or formalities. You don’t need to file anything with Companies House, and there are no ongoing obligations. Still, your personal assets are at risk if your business gets into financial difficulties or fails. Sole traders are responsible for paying tax on their profits as individuals, meaning that you have to pay income tax on your earnings as usual and pay National Insurance contributions on your self-employed earnings. You can make a claim for your business expenses against this income, just as an employee would.
What is a limited company?
A limited company is a separate legal entity that can employ staff and borrow money on the strength of its assets. A limited company offers several benefits compared to trading as a sole trader. When accepting work, you can be more selective and set up a formal payment structure. You can also claim tax deductions against your profits as an expense, so it’s worth checking if you’re eligible for corporation tax relief. The most crucial benefit of setting up a limited company is reducing personal liability. If your company is ever in financial difficulty, your personal assets are protected because they are separate from the company. Other benefits include more accessible access to finance and eligibility for specific government contracts that only go to companies.
Advantages of being a sole trader
There are many advantages to individuals setting up as a sole trader, including;
- There are no tax or legal implications, and you don’t need to find investors or set up a new company.
- You can tailor how you operate your business without the pressures of following a company’s bylaws.
- You have complete control over your finances. If you want to cut your costs and are comfortable balancing your books yourself, it may be the right choice.
- It’s easy to set up and doesn’t have any ongoing obligations. You can decide when to end your business and shut it down, unlike a company where you have to go through a formal winding-up procedure.
- You can make a claim for your business expenses against this income, just as an employee would.
- You don’t have to pay Corporation Tax on your profits, although you have to pay National Insurance contributions on your self-employed earnings.
Disadvantages of being a sole trader
When looking at being a sole trader or limited company, the disadvantages of being a sole trader include;
- You’re personally liable for your company’s debts, so your personal assets are at risk if something goes wrong.
- If you have a lot of debt, it can be challenging to get financing. –
- You’re responsible for all the administration, accounting, and taxes.
- Managing your cash flow may be more difficult if you don’t have regular pay coming in.
- Your business might struggle if you’re not organised and good with numbers.
- If your company ever goes into the red, you might feel shame or guilt that could affect your productivity.
- If you’re only working part-time, it’s harder to transition into full-time work because your business is not necessarily scalable.
Advantages of setting up as a limited company
Choosing to be a limited company offers you;
- You have limited personal liability. If a client sues you, the client cannot go after your personal assets. If a sole trader’s client sues, the client can go after the owner’s assets.
- You’re eligible for specific government grants. If you set up as a limited company and fill out the correct paperwork, you can apply for government grants and loans, such as the BIG or the SCORE grant.
- You can claim business expenses. You can write off expenses such as office space, supplies, computers, furniture, and money invested in your business.
- You can quickly raise investment for your business. Investors are more willing to put money into a limited company than a sole trader.
- Setting up as a limited company takes time and effort. While this isn’t ideal, it’s worth it when you consider the benefits.
Disadvantages of setting up as a limited company
Disadvantages again of sole trader or limited company are;
- You have to file annual accounts.
- You must file audited financial statements with Companies House at the end of the financial year.
- It costs money to register as a limited company. Companies House charges £16 to register a limited company.
- You must pay corporation tax on all profits earned by your company.
- You need an accountant to file the annual accounts. While this isn’t a big deal, it’s something that a sole trader doesn’t need to worry about.
Key takeaway: Sole Trader or Limited Company?
There’s no right or wrong answer when it comes to the question of a sole trader or limited company. It all comes down to your individual situation and what’s best for you. But it’s essential to weigh up the benefits and drawbacks of each. If you decide to go with a sole trader, make sure you know the increased personal liability. If you choose to go with a limited company, be prepared for the paperwork that comes with it.