Limited Company Versus Sole Trader – what’s right for your new business?

All organisations, regardless of size, must have a legal structure, most being either a sole trader or limited company. 
Chartered Certified Accountant
Hayley Hedges-Quinn
Approximately 3.5 million individuals set up as sole owners in 2020, accounting for 59% of small businesses, making sole trading the most popular legal structure in the UK at that time. However, 2 million limited companies also registered in 2020, making limited companies the UK’s second most popular choice.

So, first things first, what is the difference between a sole trader and a limited company?
If you’re a sole trader:
  • you run your own business as an individual and are self-employed
  • you can keep all your business’s profits after you’ve paid tax on them
  • you’re personally responsible for any losses your business makes
  • you must also follow certain rules on running and naming your business.

A limited company is a company limited by shares or limited by guarantee.

Limited by shares companies are usually businesses that make a profit. This means the company:
  • is legally separate from the people who run it
  • has separate finances from your personal ones
  • has shares and shareholders
  • can keep any profits it makes after paying tax or pay it out to shareholders as a dividend

Limited by guarantee companies are usually ‘not for profit’. This means the company:
  • is legally separate from the people who run it
  • has separate finances from your personal ones
  • has guarantors and a ‘guaranteed amount’
  • invests profits it makes back into the company.

It is always good to discuss through ideas with your accountant first, before starting a business. The difference between choosing to become a sole trader or a limited company will depend on your personal circumstances and business concept. Your accountant should offer full advice as to which is the better option for your individual situation.

This article helps explains five important facts you need to consider before choosing which legal structure is best for you and your business.
Profit Level
The initial predicted level of profit your business is likely to make will affect your decision on whether to become a limited company or sole trader. 

Generally speaking as a sole trader you will pay less tax than a limited company if your taxable profits fall between £1 - £20,000. The additional costs incurred with running a limited company negate tax savings at this level. Above the £20,000 threshold you’re better off forming a limited company as you will save more tax on profits than as a sole trader.
Personal Circumstances
Limited companies can benefit married couples where one spouse has little or no income of their own. In these situations, dividend splitting is used as a legal way of paying less tax on income. The low-earning or non-working partner’s tax allowance can be used to lower the tax rate made on dividends rather than all the income being assessed on one person. 
Third party liability
One of the most attractive aspects of becoming a limited company is exactly that, the limited bit! Limited liability means you are not personally liable for financial losses, which can give extra peace of mind. If shareholders retire, the business continues to operate regardless of their involvement, which also protects the job security of employees. Limited companies can also find it easier to receive business loans and investment as the business is a separate entity from its owner.
To pay or not to pay (National Insurance)
Sole traders are required to pay Class 2 and Class 4 National Insurance Contributions (NCIs) on their salaries. However there are no NICs on dividends drawn from a limited company and basic rate taxpayers pay a lower personal tax rate of 7.5% on dividends above the tax-free annual amount of £2,000.
Trading losses 
As a sole trader, you will make a loss in your business whenever your expenses and capital allowances are more than your sales income or turnover. However, as a sole trader, your trading loss can be set against other income in the same year for example, setting your loss against your rental profits in the same year. Losses from a limited company can only be used against the company’s previous or future losses, not against personal income.
There are many more aspects regarding the differences and benefits pertaining to both sole traders and limited companies, but these top 5 sole trader versus limited company points are a sound starting point to hopefully shed light on which legal structure is the best option for you. 

If you would like to chat through any of these points in more detail or discuss other areas which concern you, please contact Hayley on 01473 657853.
Follow Hayley on Linkedin and join the mailing list