Sole Trader Vs Limited Company – What’s best for you?

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It’s often the first question asked when starting a business. Should I be a sole trader or a limited company? What’s the difference, and which is best?

Perhaps you’re already a sole trader and thinking about changing to a limited company but wonder if it’s worth it?

If you run a business or are about to start, here’s some help to decide if you should be a sole trader or limited company.

What is a Limited Company?

A limited company is its own entity, separate from you and your personal finances. All transactions, borrowing, expenses, costs and ‘liabilities’ are limited to the company’s shareholders – hence the name ‘limited’.

When you set up a limited company, you usually become a director and shareholder, (though you can be without one without the other). Your company can pay you a salary (usually set low to limit personal taxation). On top of that, you can take dividends from company profits to top up your personal income. Dividends are subject to a new dividend tax though. This is 0% up to £2,000. After that, the first £34,500 is taxed at 7.5%. The rate goes up to a maximum of 45%. (See the payment examples below).

Yorkshire Accountancy can advise you on how to minimise your tax liability by paying the right amount of salary Vs dividend.

A limited company usually has an accountant to do its statutory annual accounts. These are based on bookkeeping records and sent to HMRC with your tax return.

Limited companies also pay corporation tax on profits – currently set at 19% and payable each year.

What is a Sole Trader?

As a sole trader, there is no separation between your business and personal finances. Your businesses profit is your income, and business debts are your personal debts. Personal assets like your house are not protected if your business should run into trouble.

As a sole trader, you can pay yourself monthly drawings (earnings) . You pay income tax based on your profits at the standard rate (0% up to £12,500, 20% 12,501 – £34,500, 40% £34,501 – £150k, 45% on anything over £150k).

Sole traders are required to keep a record of expenses and costs but do not have to file annual accounts with HMRC. You do need to complete an annual tax return, but overall there’s less paperwork than a limited company so accountancy charges tend to be less.

National Insurance – Limited Company Vs Sole Trader

For a limited company, National Insurance is payable on directors’ salaries and bonuses at the rate of £3 per week for anything earned above £12,500. If you employ someone, you (and they) pay

National Insurance too. Most payroll services will automate this for you. A good accountant will assess the tax efficiency here and determine the optimum amounts to take.

The National Insurance charge for sole traders changed in April 2019 and you now pay £3.00 per week (paid annually) if your profit is more than £6,365 per year plus 9% on profits between £8,632 and £50,000 plus 2% on anything over £50,000.

Who Pays the least Tax Sole Trader or Limited Company?

Many people form limited companies because on balance they will pay slightly less personal tax than as a sole trader. This is sometimes offset because the business will be pay corporation tax and limited companies often have higher accountancy costs. Limited companies with a profit in excess of £40,000 will save over £1,000 in tax overall.

Raising Capital

As a limited company, you can develop your own credit profile, different from your personal credit rating. Potential investors are more likely to invest in an actual company than a sole trader. Loans are also limited to the company, so you do not become personally liable for the loan if the business should cease trading. However, some lenders will ask you to sign a personal guarantee for a loan which will by-pass this limitation.

If you’re a sole trader you can still borrow capital, but it will be subject to your own credit rating. You will also be personally liable for this loan should the business cease trading.

Examples of how you pay Yourself: Limited Company Vs Sole Trader

Let’s imagine ‘Sarah’ sets up a limited company as an eBay trader.
• Her revenue from sales is £65,000 in one year.
• Her costs (including paying herself a basic wage within the NI threshold – roughly £8,424 per year per director) are £25,000.
• Sarah’s net profit is, therefore, £40,000.
• She will then pay 19% (£7,600) in corporation tax leaving a profit after tax of £32,400.
• She then decides to take the remaining profit of £32,400 as a dividend.
• On that £32,400, she will get the first £2,000 tax-free and then pay 7.5% (£2,280) in dividend tax on the remainder.

As a result the total tax in this example is £7,600 (CT) and £2,280 (IT) = £9,880.

If Sarah had the same performance as a sole trader her profit would have been £48,424 (she cannot take a wage from a sole trader business). As previously explained she will pay 20% tax on anything above the current tax threshold of £12,500 plus NI.

Based on £48,424 she will pay the following: –
• £7,184.80 in tax
• £156.00 in class 2 NIC
• £3,581.28 in class 4 NIC

As a result, her total tax and NI is £10,922.08.

*All figures are approximate and based on 2019 tax rates.

Prestige and Confidence

Setting up a limited company will give more prestige and assurance to your clients if you are trying to attract more business customers. For example, as a consultant or contractor, potential clients will be more assured by the fact you are a fully fledge limited company rather than a sole trader.

If you’re an online trader or sell directly to the consumer, or supply behind the scene services this might not matter as much.

What’s best for you? Limited Company or Sole Trader?

Yorkshire Accountancy can help you decide what’s best for you with a few simple questions. A lot depends on how you see your business grow and if you want to expand. We have services available for both sole traders and limited companies and always focus on what is right for you based on what you tell us.

Ask us – Get some free advice: Call Nick Robinson on 01482 845750.

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