When starting a business, there is a lot of key decisions to make - one of them being the structure of your organisation. Most small businesses within the UK will either operate as a sole trader or a limited company. Each have their positives and drawbacks, so it’s important to examine both structures in order to help you decide what is best for your business. 

What are the differences between a sole trader vs limited company?

Setting up as a sole trader is the easiest and simplest way to set up your own business. When an individual registers themselves as a sole trader, that person alone becomes the sole owner of that business, and is responsible for all actions, financing and transactions that business takes. Setting up as a sole trader is relatively straightforward: you register your business on the GOV.UK website, and you will be able to commence trading. 

Creating and running a limited company is a little more complex - when you register a limited company, that business then creates its own legal identity. Whereas a sole trader becomes directly responsible for any actions that organisation takes, a limited company director’s assets outside the business do not become liable. An accountant, such as Nixon Williams, can help you get set up.

What are the advantages and disadvantages of setting up as a sole trader?

Both business structures have their own advantages & drawbacks. Below we will examine the benefits and pitfalls of setting up as a sole trader. 

Advantages

  • Becoming a sole trader is relatively easy and is not a complicated process. It involves minimal paperwork and admin.
  • As a sole trader you have more freedom when accessing the organisation finances. For example, you can borrow from the organisation’s business account, as it is essentially yours.
  • You have greater privacy as a sole trader. Whereas limited organisations have to register their accounts each year, sole traders do not.

Disadvantages

  • Sole traders are not viewed as a separate entity within UK law. This means that sole traders have unlimited liability and if the organisation goes into debt, the owner’s personal possessions & assets become liable. 
  • When setting up as a sole trader, you may only have a personal pension. Limited companies, on the other hand, can potentially design pension schemes which are far more generous than personal pensions.
  • In comparison to limited companies, tax on sole traders is a lot higher. When you begin to go over a certain salary threshold, it would not be advisable to still be set up as a sole trader. 

What are the advantages and disadvantages of setting up as a limited company?

Like with sole traders, there are advantages & disadvantages to setting up a limited company. We have outlined some of the main pros & cons below.

Advantages

  • As mentioned earlier, limited companies have limited liability. This means that the business itself is a separate entity to the individual’s that run the organisation, therefore if the organisation has debts owed, the organisation is responsible for it, not the directors & shareholders. 
  • Limited organizations face a ‘kinder’ tax rate than sole traders once they get past a certain threshold. Whereas sole traders pay income tax, limited organisations will pay corporation tax, which is more often than not, alot smaller than income tax. This means that a limited organisation will typically be more profitable than a sole trader. 
  • There are greater allowances & tax deductible costs available for limited companies, which would not be available to sole traders. 

Disadvantages

  • Unlike sole traders, limited companies will need to file yearly account with Companies House. This can be complicated, but can be made easier with a dedicated accountant. Filing your accounts also takes away the level of privacy you recieve.
  • Whereas setting up a sole trader is fairly straightforward and features minimal paperwork, setting up a limited company takes time and effort - and often requires a dedicated accountant to do this. 

The main tax differences between sole traders vs limited companies

Sole traders

When an individual sets up as a sole trader, it is important to consider that the sole trader will be paying income tax, rather than corporation tax. 

Income tax will be applicable when a sole trader exceeds their personal allowance of £11,500, where they will pay 20% tax up until they reach an income of £45,000. 

This is then increased further to 40% on income over £45,000 and 45% on income of £150,000. 

There is also considerations to be made on National Insurance costs, as you will be liable to Class 2 and Class 4 of National Insurance pricing. This is based on how much profit you have in your income after tax each financial year. You will rank in Class 2 if your profits are £6,205 or more a year. This would mean you pay £2.95 per month on National Insurance.

If you earn over £8,424 or more a year, you fall into Class 4. With Class 4, you will have to pay 9% tax on profits between £8,424 and £46,350. Furthermore, if you are above the £46,350, you will have to pay 2% on National Insurance. 

Finally, it’s important to realise the considerations with benefits and incentives you could potentially lose as a sole trader, such as child-care benefit, which begins to be reduced once you pass an income of £50,000. 

Limited companies

In contrast to sole traders, limited companies pay corporation tax, rather than income tax. 

Corporation tax is currently set at 19% within the UK (with this being reduced to 18% in 2020). In addition to this, personal income tax may come into play when paying yourself dividends out of the organisation as a form of salary. 

Directors of limited companies can pay themselves a small salary which would be accordance to their personal allowance, however they would look to stop before costs for National Insurance become applicable. 

The rest of any remaining cash can be paid in the form of dividends, after tax. There is no National Insurance to be paid on dividends, and currently the rate of tax for dividends is at 7.5%, with rates of of 32.5% & 38.1% in higher bands. The first £5,000 taken out as dividends is currently tax-free. 

There is no legal requirement for a director to withdraw all of their money out of the business at one time. It is usually considered that having cash within the business for withdrawal at a later date or for re-investment within the business is more economically sound in the long-run.

So, what is best for me?

There is a lot to consider when you make the decision to work either as a sole trader or through your own limited company as both routes have their own pros and cons. Ultimately, the decision will fall to to what works for your unique circumstances. That’s why it’s important to consider how each business structure will work for you and your profession.

How can Nixon Williams help?

Whether you are just starting out and want advice on how best to establish yourself, or you have built up your business and want to make the most of the tax advantages available to you, then our accountants can help. 

With an in-depth understanding of the issues involved and plenty of experience helping contractors and small businesses to achieve their potential, our accountants are always on hand to offer the benefit of their expertise. 

For more information on the packages we offer and the support we can provide, call us today on 01253 362062 or email us at newbusiness@nixonwilliams.com.