Sole Trader vs Limited Company

Sole Trader vs Limited Company – the Pros and Cons

PC Payroll & Legal can help in a number of areas if you are setting up and running your own business. Here we look at the differences between being a sole trader or setting up a limited company.

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Sole Trader: Overview

If you’re a sole trader, then YOU are the business: Its profits are your income (so you may not able to easily minimise your tax bill), its debts are your debts, and its mistakes are your mistakes – you can be sued and made personally liable if something goes wrong.

Tax, NI, and VAT for the Sole Trader

Here are the rules for you – if you take on employees, you’ll need to pay tax and NI for them, too.

Income tax

You pay income tax on your business’s profits – its income (less any allowable expenses or allowances) are added to your own income on your tax return.

One of the disadvantages of being a sole trader is that your business’s income is your income, so it’s harder to reduce your tax bill. Plus you can’t pay yourself in dividends rather than salary as a way to reduce your tax/NI bill, as you can with a limited company.

You’ll need to complete a tax return each year to pay your tax.

National Insurance

You’ll have to pay Class 2 national insurance contributions if your earnings are above £6,475 this is a flat-rate of £3.05 in 2020/21.

You may also have to pay Class 4 National Insurance contributions; the amount of which you have to pay for is based on your profits for that year. You pay 9 per cent on annual profits between £9,500 and £50,000 (2020-21) and 2 per cent on any profit over that amount.

Our team can help with setting up and running payroll.

VAT

As with any business, if your turnover is expected to exceed £85,000 a year, you’ll have to register for VAT.

Your Business Name

You’ll need to choose a unique business name.  You can trade under your own name, or you can set up a business name. There are various rules about choosing a business name. One of the key ones if you’re a sole trader is that you can’t put Ltd at the end. Also, make sure that no one is using your name. 

If you use a business name, you are required to disclose your name as well and a relevant address (EG where documents can be served) on things like websites and receipts. 

Administration for the Sole Trader: Good News

You don’t need to deal with Companies House – so no registering or annual returns. Being a sole trader involves less paperwork, which is the attraction for many people. You’ll still need to keep records of your income and expenditure, however.

You should still keep a separate bank account for your business – it will make filling in your tax return much easier, if nothing else.

Liability for the Sole Trader: Bad News

Think very carefully about the risk you are taking on. You are the business – and if you can’t fulfill a contract, for instance, you can be sued. If you were, you might lose your house.

This is one of the key disadvantages over a limited company.

Our self-assessment services are designed to help sole traders.

Limited Company: Overview

If your business is a limited company, it is owned by its shareholders. Even if you are the only shareholder, the business’s assets and liabilities are separate to yours: You are protected from its liabilities (if the company can’t afford to pay its bills because a customer won’t pay, instance) but the company’s assets are its own – so there are rules on withdrawing the money, for instance. Reporting and accounting requirements are more onerous than as a sole trader but it’s easier to arrange to take money out of the company in a tax-efficient way.

Tax, NI, and VAT for the Limited Company

The company’s tax affairs are separate to yours. You need to account for its income and expenditure, and you’ll pay corporation tax on the company’s profits.

Income tax

Owners of businesses set up as limited companies often pay themselves a low wage, and take money out of the company as dividends (as a way to minimise tax and NI payments). You have to pay income tax via PAYE on any salary you pay yourself.

If you pay yourself a dividend (and in any case if you’re a director of the company), you’ll have to fill out an annual tax return.

National Insurance

By paying yourself a dividend (and a low salary), you can reduce your national insurance payments. NICs affect your entitlement to benefits, so don’t avoid them altogether (and nor can you if your business is successful – you’ll have to pay yourself at least the minimum wage, which will take you into NIC territory).

As a director, you’re an employee of your company. So you pay Class 1 primary NICs at 12 per cent on your earnings between the earnings threshold (£792/month in 2020/21) and the upper earnings limit (UEL: £4,167/month in 2020/21). Above the UEL, you pay at a rate of 2 per cent.

The company has to pay Class 1 secondary contributions – 13.8 per cent (in 2011/12) on the earnings over the earnings threshold. The company may also have to pay class 1a contributions on certain benefits in kind, like a company car.

Our team can help with setting up and running payroll.

VAT

As with any business, if your turnover is expected to exceed £85,000 a year, you’ll have to register for VAT. There are pros and cons to this as set out above.

Our team can help you with your VAT registration and quarterly VAT reporting.

Corporation Tax

Your business pays corporation tax on its taxable profits. The rules for corporation tax are more complicated when you set up your business. But that aside, it’s essentially based on the company’s income less its costs, allowances, reliefs, deductions etc. Corporation tax can be complex but whatever your situation, make sure you tell HMRC that the company is liable for corporation tax and that you pay it and file the company’s return on time.

In 2020-21, you pay corporation tax at a rate of 19% your profits. It’s generally easier to get an accountant to do all this for you.

Setting Up Your Company

Before you begin trading, you need to register your company with the Registrar of Companies (Companies House). You’ll need to fill out various forms, and you’ll pay £12 to Companies House and a fee for a set of Articles of Association.

Administration for the Limited Company: Bad News

There’s a lot more paperwork to do if you’re a limited company – separate accounts and returns, filings to Companies House and so on. If you’d rather concentrate on running the business, get your accountant to sort all this out, at least until you’ve got time and are confident about what’s needed.

Liability for the Limited Company: Good News

The business is separate to you. So, its debts are not yours. However, if you’ve had to guarantee any loan you’ll still be liable for this. And there are obligations on directors, so if the business is in trouble, take professional advice. If you get this wrong, you can still become personally liable, as a director, for the company’s debts.

Need more help?

Contact us about your payroll or legal needs

We have a comprehensive range of payroll, pension and legal services to help you save time. Speak to our highly experienced and friendly team to get started.

Need more help?

Contact us about your payroll or legal needs

We have a comprehensive range of payroll, pension and legal services to help you save time. Speak to our highly experienced and friendly team to get started.

About PC Payroll & Legal

PC Payroll & Legal was established in 2011. We help families stay legal and save time with our nanny payroll, pension and legal services. We help small business owners and the self-employed focus on running their businesses by offering outsourced payroll, workplace pension administration, business administration, HR advice and legal services. 

PC Payroll & Legal is part of the Working Life Solutions Group of companies. The Working Life Solutions Group includes Your Employee Wellbeing which offers wellbeing support programmes for businesses of all sizes.

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