The difference between a Sole Trader and a Limited Company

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Do you know the difference between a Sole Trader and a Limited Company? Well if you don’t then we’re here to help you. Whether you’re starting up your business or you’ve been trading for years, we’re here to help you to be able to choose the right way to operate your business.

A Sole Trader

If you’re a sole trader…

You can keep all your business’s profits after you’ve paid tax on them.

  • As a sole trader, you are Self-employed.
  • You can run your own business as an individual and are self-employed.
  • Run your own business individually.
  • You’ll be personally responsible for any losses that your business makes.

You must be registered with HMRC for self-assessment and if your turnover is £85,000 or more, you must register for VAT.

From April 2021, you must register for the Making Tax Digital for VAT service.

Being a sole trader is financially better for some small businesses, but it is a risk to take on the full liability. The worst-case scenario is being forced to apply for bankruptcy, which could lead to losing your house, possessions and damaging your credit.

A Limited Company

A limited company is legally separate from its director or directors. So, you aren’t responsible if the business runs into financial problems (excluding criminal activity). And a director’s personal assets such as here, house and car, will be protected if the company is liquidated.

However, a limited company can be very complicated as there are more admin and other duties required by the director or directors. So that’s why having an accountant is usually a necessity.

A limited company must register with Companies House for a fee and name at least one director and one guarantor, who can be the same person. If a company’s turnover is £85,000 or more, it must also register for VAT and use the Making Tax Digital service from April 2021.

Difference between getting paid – A Sole Trader VS A Limited Company

The main difference between them is the way you pay tax and yourself.

Operating as a limited company you have to pay Corporation Tax of 19% on any annual company profits. As company directors usually pay themselves both a salary and dividends, only the salary will be subject to Income Tax and National Insurance. Their yearly salary and dividends will still need to be declared in an annual tax return and they will still receive a standard Personal Allowance of £12,500 unless their total income and dividends are over £100,000.

Operating as a sole trader, you can keep all your profits after you’ve paid income tax on them. The rate of income tax you pay depends on your income. Currently, there is a Personal Allowance of £12,500 which you pay 0% on, the Basic rate £12,501 to £50,000 is 20% and the Higher rate £50,001 to £150,000 is 40%.

But which is better?

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Benefits of a sole trader

If you think you will remain a small and simple business, then being a sole trader is the best choice for you. Your accounting process will be easier, so you may not even need an accountant, simpler to pay yourself, less paperwork and you don’t need to share business information with the public, keeping your finances private.

Benefits of a limited company

If you intend to make your business larger and hire multiple employees, a limited company is a better option. You can make more profit as a limited company. Your company’s credit rating doesn’t rely on your personal credit rating, meaning you can borrow more to invest in and expand your business. If you create a popular brand and business but decide you want to do something else, it’s also far easier to sell a limited company.

Changing from a sole trader to a limited company

If you want to switch to trading as a limited company, there are several things you’ll need to do.

You may want to look into having an account ready to help you with your limited company if you don’t already have one! 

Here is a Step by Step guide from the government: step by step plan for setting up a private limited company.  

The guide will include key things such as:

  • Checking you can use your existing business name as your company name.
  • Setting up a separate business bank account, if you don’t already have one.
  • Registering your company with Companies House.
  • Working out how you want to pay yourself.
Let us know if you followed any of these tips or did something we haven’t mentioned below, we would love to hear from you! 

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