Sole Trader vs Limited Company

The pros and cons for your small business

When you start out in your own business, it’s not uncommon for you to find yourself as a one-person operation. You will oversee your own accounts, sales and marketing and everything regarding the products and services you provide.

But is going into business and setting up as a sole trader the same thing?

We take a look at the differences between being a sole trader or a limited company. We will examine the pros and cons each option has to offer. This will help you to weigh up the best option for yourself and your business.

Sole trader

Sole traders are individuals, formally recognised by HMRC who run a business for themselves. They are often referred to as self-employed or freelancers. However, the official term for such people is ‘sole trader’.

When you register with HMRC as a sole trader, you must keep appropriate financial records and pay any taxes due. This includes tracking all eligible expenses, issuing invoices for any work undertaken and submitting self-assessment returns confirming your taxable income.

When to set up as a sole trader

You will need to set up as a sole trader if any of the following apply:

  • If you have earned more than £1,000 from self-employment between 6 April 2020 and 5 April 2021
  • You need to prove you’re self-employed, for example to claim Tax-Free Childcare
  • You want to make voluntary Class 2 National Insurance payments to help you qualify for benefits

Usually, tax is deducted at source through the Pay As You Earn (PAYE) scheme. Sole traders however, use self-assessment to calculate their tax burden which is paid to HMRC twice a year. This is unlike being a traditional employee of another organisation,

Alongside these tax payments, sole traders usually need to pay Class 2 and Class 4 National Insurance Contributions (NICs). The amounts are calculated automatically when you submit your self-assessment form online. You can find out more about this on the government’s Self-employed NI rates page.

Pros of a being sole trader

  • It’s easier to set up as a sole trader: there’s less paperwork (although you still have to complete an annual tax return) and you don’t need to register with Companies House.
  • You have a greater level of privacy than limited companies: if you set up a limited company, some of your personal details will be published in the records of Companies House. However, you’ll need to put some information out into the public domain if you’re to market your business effectively.

Cons of a being a sole trader

  • You have full liability if your business gets into debt: it’s possible to protect yourself from such things through the likes of professional indemnity insurance and payment protection insurance, but keep in mind that liability for your sole-trader business ultimately lies with you.
  • You may be at a disadvantage when bidding for big contracts: even if you are providing exactly the service a client is looking for, internal policies may rule you out because you’re a sole trader and they’ve decided to work only with limited companies.
  • You may not be eligible to claim tax reliefs: you have to be within the charge of corporation tax to be eligible to claim Research & Development tax reliefs and the creative industries tax reliefs. Therefore you have to be a limited company in order to claim these reliefs.

Limited company

A limited company has its own legal identity and is structured as a business with shareholders and directors. The company can be run by just one person, however the setup is more involved than being a sole trader.

For limited companies run by an individual, the person in question becomes the director of the company and shareholder. They will take their remuneration by way of a salary, dividends (or a mix of both) from the business profits. How to remunerate yourself can be complex, but we can help to remove the complication.

To set up a limited company, you need to register with Companies House. You must file an annual confirmation statement and annual company accounts each year which will be on public record.

Pros of being a limited company

  • They may feel more trustworthy to some clients: a limited company can give the impression of a greater sense of permanence and financial success.
  • Limited liability: financial liabilities are placed on the company rather than on the individual(s) running the company. Generally, that means your personal assets aren’t at risk if you run a limited company.
  • They can be more profitable: limited companies pay corporation tax rather than personal income tax. You also have far more flexibility in terms of how you remunerate yourself, affording you more tax planning opportunities.
  • You have the potential to save more than sole traders: as a limited company, you can take advantage of a greater range of tax-deductible items. Those who plan for gradual growth sometimes start a business as a sole trader. They later switch to becoming a limited company.

Note that you may still need to apply for a registered trademark, if that’s relevant to your business.

Cons of being a limited company

  • More paperwork: It takes more effort to set up a limited company, and the ongoing reporting requirements are more onerous including filing the accounts with Companies House and the Corporation Tax return with HMRC. It’s advisable for limited companies to engage an accountant to keep their finances in order.

Whether you become a sole trader or limited company you should also consider whether you need to be VAT registered. VAT registration is compulsory if your business’ annual turnover exceeds the VAT threshold. This is currently set at £85,000 per year.

We’re happy to talk you through your options when setting up your business so you can make the best decision. Get in touch on 01903 23094 to discuss your needs further.