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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.
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.
Both business structures have their own advantages & drawbacks. Below we will examine the benefits and pitfalls of setting up as a sole trader.
Like with sole traders, there are advantages & disadvantages to setting up a limited company. We have outlined some of the main pros & cons below.
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.
In England, income tax will be applicable when a sole trader exceeds their personal allowance of £12,500, where they will pay 20% tax up until they reach an income of 37,500. This is then increased further to 40% on annual earnings from £37,501 to £150,000 and 45% on income over £150,000.
There are also considerations to be made on National Insurance costs, as you may be liable to Class 2 contributions of £3.05 per week and Class 4 National Insurance contributions of 9% on profits between £9,500 and £50,000. For profits in excess of £50,000 you will pay Class 4 National Insurance contributions of 2%.
Finally, it’s important to realise the considerations with benefits and incentives you could potentially lose as a sole trader, such as child benefit, which begins to be reduced once you pass an income of £50,000.
Note that the tax rates and allowances may be different for people living in Scotland or Wales. Please contact us for more information on these rates.
As a limited company director, you and the business will be viewed as separate entities for tax purposes. Your business would be taxed on the income it makes (via corporation tax), whilst you would be taxed personally on your personal income from the company (in the form of income tax, National Insurance and dividend tax).
In comparison to operating as a sole trader, your limited company will pay corporation tax on its taxable profits. Company tax rates are lower than rates of income tax and corporation tax is charged at a flat rate of 19%.
Unlike sole traders, limited company directors do not pay Class 2 or Class 4 National Insurance. Directors are classed as company employees, so they pay Class 1 National Insurance. Both employer’s and employee’s National Insurance is payable on directors’ salaries and bonuses.
If you operate as a limited company director, it is likely that your tax liabilities will be less than as a sole trader. This is because most directors with the advice from accountants will choose to pay themselves a small salary and take the rest of the profit as dividends. The rate of tax on dividends is currently 7.5% income below £35,000, 32.5% up to £150,000 and 38.1% on anything above £150,000. You can find more information about the difference between salary and dividends here.
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.
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.