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Sole Trader vs Limited Company

One of the biggest decisions when setting up as a business is whether to go down the sole trader or limited company route. Fortunately, we've put together a guide to give you all the details for an informed decision.

The road to starting your own business is full of difficult decisions. But one of the most important choices is deciding whether to set up as a sole trader or as a limited company. Picking the wrong route could have long-term implications for your business, and it could even stifle future opportunities when it comes to getting new clients.

Below we'll look at the pros and cons of each, as well as how to get set up. So, let's get started.

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Sole trader

A sole trader is self-employed and runs their own business as an individual. The company and the person are not separate entities - so, as a sole trader, you're personally responsible for any losses the business makes. Likewise, you keep all of the profits after you've paid tax on them.

Sole traders are personally responsible for recording all financial affairs of their business. This includes sending a Self Assessment tax return every year and registering for VAT if your takings are over the VAT threshold.

How to become a sole trader

Setting up as a sole trader is a pretty simple process. Firstly, you'll need to let HMRC know that you're now self-employed. Then, you'll need to register for Self Assessment as a sole trader. Remember, you'll need to have a business name ready when you register.

After that, you're pretty much good to go (provided you have any industry-specific licences in place).

Our guide to setting up as a sole trader contains everything you need to know about this process.

Advantages and disadvantages of working as a sole trader

There's plenty of points to consider when deciding if the sole trader option is right for you. To find out more about the benefits and challenges you may face as a sole trader, take a look at our guide to the advantages and disadvantages of working as a sole trader.

Limited company

A limited company is a business that is an entity in its own right. That means it is separate from the individuals who own the company, and their liability is limited to the investment they made. (hence the name 'limited').

Limited companies tend to work on a 'shares' basis. Shares mean that the company is divided into smaller portions with a monetary value attached. These shares are then distributed among the shareholders.

All limited companies in the UK need to be registered with Companies House, and they must follow the rules laid out by the Companies Act of 2006.

How to become a limited company

There's no denying that there's more paperwork involved when setting up a limited company versus getting started as a sole trader. Fortunately, there are specialists who can help you through the process in a simple, quick, and cost-effective way.

Here at Caroola, we can form your limited company online in just five minutes. That includes setting up your company bank account and registering your company for VAT and PAYE.

You'll also need to appoint an accountant, who'll be able to advise you on the most tax-efficient way of working through a limited company. We can help there, too. Check out our guide on finding out what an accountant can do for you.

Advantages and disadvantages of working through a limited company

There is a lot to consider when deciding on how to structure your company. If the limited company route is of interest to you, our guide to the advantages and disadvantages of working through a limited company contains a full breakdown of the points you must consider.

Differences between sole trader and limited company

Let's take a look at some of the key differences between operating as a sole trader and a limited company:

  • The most significant difference is with liability. As we mentioned above, as a limited company, you are only ever liable for the amount you invested in the business. But, as a sole trader, you are personally responsible for all losses that your business might make.
  • The paperwork involved as a sole trader tends to be a bit more straightforward than a limited company. But, this is offset by limited companies generally being more tax efficient.
  • Sole traders are self-employed, whereas limited companies can range from one person to many hundreds.

Will I earn more money as a limited company or sole trader?

If profits are above £25k per year you may well benefit from going limited; however even if your profits are lower it’s probably still worth having a chat with an accountant as they are able to find ways to make your company more tax efficient. Our Take Home Pay Calculator will show you how much you can earn by going limited.

Is a sole trader mortgage easier to get than a limited company mortgage or loan?

Some banks look more favourably on directors of limited companies, but it really does depend on the bank. Since the advent of self-certification, it shouldn’t really matter.

What rate of tax do I pay as a sole trader compared to that of a limited company?

A ‘small’ company will pay the company (corporation) tax at 20% on its profits. How you will be taxed personally is dependent on the level of income that you draw from the company. This income can be structured in a tax efficient manner.

You also have the option to leave ‘reserves’ in the company to help with future growth and development (remember, with a limited company you only pay personal tax on the money you take out of the business). As a sole trader or partnership, you will be taxed on the profits of the business as they fall, not on what you have drawn from the business which is not as flexible in terms of future tax planning.

How do I decide how much to pay myself and how much to leave in the business?

This is entirely up to you, as long as the business can afford it. You need enough to live on, but there is no point taking out more than you need and being taxed personally on it.

Profits are usually taken as dividends which do not attract National Insurance, which may help reduce your overall tax liability.

Do I have to be registered for VAT to be a limited company?

VAT registration is the same for both sole traders and limited companies. You are not obliged to register until you meet the turnover threshold as a company or a sole trader but you may choose to register as they may well be good tax reasons to do so, call us or check with your accountant.

What happens if I change my mind and decide I don’t want to be a limited company after all?

All you have to do is complete a form to be removed from the register of companies at Companies House.

Sole trader or limited company?

So, we've looked at the definitions and the differences between a sole trader and a limited company. But which is the right choice for you? Well, the short answer is: it depends.

If you're comfortable staying as a small business and are satisfied with paying more tax. There's no reason why working as a sole trader wouldn't be suitable.

But if you think you'll want to grow your business, operating as a limited company might be the best option. Clients and investors will see you as more credible, and your personal assets won't be at risk if you choose the limited company route.

Here to help

There's no doubt that deciding whether to set up a limited company or as a sole trader is a big decision. But we hope this guide has helped inform you about making the best choice for you and your business.

For support and guidance on structuring your business, simply get in touch.

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