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As someone who may have just started working self-employed, you may be unsure about whether you carry on as a sole trader or incorporate a limited company and trade through this instead. It’s crucial to understand the differences, both tax and legally, between the two to ensure you are making the most informed decision. Before we get into the detail of each, let’s establish what the terms ‘sole trader’ and a ‘limited company’ actually mean.

What is a ‘sole trader’?

As the name suggests, a sole trader is someone who runs their business as an individual and has full ownership. As a sole trader, you and your business are one legal entity and you’ll get to keep all profits once your tax liability has been paid. As one entity, you’ll pay your tax bill annually, via your self-assessment, based on the profits you’ve made in the tax year.

As one legal entity, sole traders have unlimited liability. This means that you are personally liable for any losses or debts incurred by the business and your personal assets, such as your house or car, could be leveraged to offset any outstanding liabilities.

What is a ‘limited company’?

If you were to incorporate a limited company, you and your business would be separate and distinct legal entities. Because you and the company would exist as two entities, you would need to pay corporation tax (for the company) and personal tax (for yourself), again via your self-assessment each year.

As the name suggests, your incorporated company would have limited liability. The benefit to you as an individual would be that if your company were to run into financial difficulty, your personal assets could not be used as a counterweight – only your company’s assets could be used to offset its liabilities.

Working as a sole trader

Some key points to note when working as a sole trader:

  • You are entitled to all the profits your company makes after tax.
  • Unlimited liability meaning your personal assets could be at risk should your company run into difficulty in settling its bills. You may find you require professional indemnity or insurance for added protection.
  • Relatively simple business structure to set up; aside from your annual self-assessment, there is little paperwork and admin.
  • Less favourable tax rates apply to sole traders in comparison to limited companies, as you’ll owe income tax and National Insurance contributions on your profits.
  • Taking holiday might be more complicated for a “one-man-band”, as you may risk upsetting your clients from downtime.
  • Sole traders’ private information isn’t available on Companies House, unlike being a director of a limited company.

Operating through a limited company

If you still can’t decide if a limited company is for you, here are some of the most common reasons why many opt to trade through an incorporated company:

  • More tax efficient, meaning you pay less tax. By paying yourself a small salary through PAYE, supplemented by dividends, you’ll maximise your personal allowance and pay a lower rate of tax. You’ll also avoid paying some National Insurance tax.
  • Limited liability meaning your personal assets are ring-fenced and can’t be used to off-set your company’s liabilities.
  • Limited companies hold more professional status and, compared to a sole trader, should find it easier to arrange finance either from the bank or through investors.

I want a limited company, but where do I sign up?

If you like the sound of a limited company, there are a couple of administrative tasks that need completing before you get there. In the first instance, you must create your limited company through Companies House. You’ll also need to set-up a business bank account to keep your personal and business finances separate. If you’d like a helping hand with this, and the ongoing admin of running a limited company, then you might want to consider whether your business would benefit from a dedicated accountant and Cobia Accounting can take care of all of this for you.

No matter the size of your business, an accountant will prove a valuable resource, taking the leg work out of searching for answers, such as the topic discussed above. Meaning you’ll spend less time scouring the internet, and more time focusing on the day-to-day operations, helping your business thrive. Click here to find out more about our services.

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