Should you register as a sole trader or a limited company?
Your business structure and legal status will be a major decision moving forward: will you operate as a sole trader or as a limited company?
A company's structure can affect almost every aspect of its operations, including how much tax you will pay, what earnings you can earn. It also affects how the company will be treated if it runs into financial difficulty. One company's methods may not be effective for another company. It's wise to weigh both pros and cons and make an informed decision.
In this article, we’ll discuss the pros and cons of being a sole trader or a limited company. Then, you can decide which business model best serves your company's needs as it grows.
What are the main differences between sole traders and limited companies?
Sole traders are self-employed individuals who own their business outright: the business does not have a separate legal identity from the owner. Sole traders take full responsibility for their actions. As soon as your business is established, you must register with the government portal as a sole trader.
The identity of the owner of a limited liability company is legally distinct from that of the company. The company has a unique identity that must be registered with Companies House (for a small fee). Thus, if the business is struggling financially, the personal finances of the owners and directors won't be affected - as they will have limited liability.
Which is better for your business: sole traders or limited companies?
This section discusses the advantages and disadvantages of both models, including earnings potential, tax efficiency, and liability.
Earnings
In the self-assessment system, sole traders keep all of their earnings after tax. In other words, your earnings are entirely dependent on your performance that year - so while there is the potential for high profits, there is also the risk that you will not earn enough money to live on.Limited company owners receive a salary, which is taxed at standard PAYE rates. Depending on their overall performance, they can also receive bonuses and dividends.
Tax
Limited companies must pay corporation tax since they are registered at Companies House. Corporation tax rates are actually lower for large companies than sole traders - making this a much more tax-efficient model for businesses with high turnovers and profits.In contrast to limited companies, sole traders are not legally required to pay corporation tax. On all profits, sole traders must pay income tax at the standard rate and National Insurance contributions.
Only your profits will be taxed, since all business expenses are deductible. More details here: National Insurance contributions guidance (.gov.uk)
Traders with lower incomes may find this form of taxation more efficient, but those with higher incomes may find it less so. Depending on your income level, you might find that registering as a limited company and paying yourself a salary is a more tax-efficient option.Generally, sole traders are subject to fewer tax obligations than limited companies, since they must file a self-assessment tax return and register as self-employed with HMRC.Due to their full liability, they can be held liable for fines or penalties resulting from late returns or paperwork errors.
Responsibilities and personal liability
As a sole trader, you have complete control over your business, and there is generally less admin to deal with, but you are also exposed to more personal risks.
Under UK law, there is no distinction between your personal assets and those of the company, so creditors can seize your personal assets (including any property you own) if you run up debts. Depending on the circumstances, you may be responsible for paying any legal costs incurred by a client or customer.
As directors of a limited company have limited liability, they are unlikely to be liable for debts or lawsuits incurred by the company (except in cases of criminal activity or negligence). The directors of a limited company cannot be made bankrupt if their company fails: their personal assets will be protected while the company is liquidated.
Therefore, sole traders must have professional indemnity or public liability insurance to protect themselves. The cost of these policies can be high, so you should consider this when deciding whether to opt for sole trading versus a partnership.
Summary
The legal model you decide to choose for your company ultimately depends on what kind of company you want to start.Those with ambitions of starting a larger company with lots of employees may prefer the simplicity and control of sole trading, while those with ambitions to do so might be tempted by the security that registering as a limited company offers, particularly in terms of liability. Your business model and future goals determine what you should do.
Comparison of Limited Companies and Sole Traders