Limited Company or Sole Trader: What’s Best for You?

The pros and cons of each

Written by 
James Morgenstern
Updated on
April 30, 2024

Limited Company or Sole Trader: What’s Best for You?

Introduction

If you're starting a business and grappling with the decision between operating as a sole trader or forming a limited company, this comprehensive guide will shed light on everything you need to know.

We'll delve into the differences, advantages, and disadvantages of each option, enabling you to make an informed decision on the path best suited to your unique circumstances.

1. Risk

From a legal and tax perspective, a sole trader is just you. You and your business are the same entity. Consequently, any legal issues that arise from disgruntled customers, suppliers, or third-party disputes could render you personally liable for any debts or legal action taken against you.

Conversely, a limited company operates as a separate legal entity. Customers and suppliers form contracts with your limited company, not you, safeguarding your personal assets if complications arise. Hence, the term 'limited' company, your liability is limited.

This 'limited liability' is a big deal and by itself could be enough reason for you to choose operating as a limited company. 

It's worth noting, however, that this protective measure does not extend to contracts that utilise your personal assets as collateral. This is very common when taking out bank loans or financial products - so watch out for this.

2. Tax efficiency

The potential for significant tax savings is another large potential benefit for operating as a limited company. Generally speaking, the more you earn, the more tax efficient the limited company route is likely to be. In actual figures, if your business generates over £50,000 in profits, you'll likely see financial benefits from operating through a limited company. However, it can depend on other variables, such as income earned elsewhere so it's still worth discussing this with an accountant if your profits are below this amount.

As we mentioned in relation to limited liability, in the eyes of HMRC, as a sole trader, you are one entity. This means you will have to pay Income Tax and National Insurance on these profits. Whereas, as a limited company, you are seen as two separate entities. Importantly, this means that whilst the company pays corporation tax on its profits, personal tax won't be due until you actually move money from the company to you. This is important, as limited companies have more control over their remuneration methods and can choose when and how they pay their directors.

For example, you can choose to build the reserves in the company to pay to yourself in a later tax year. This may be beneficial if you have already earned a significant amount within the current year to avoid going into a higher rate of tax. In terms of the how, you can also choose to remunerate yourself via a combination of both salary and dividends. Dividends in particular can offer tax savings on income above the personal allowance:

For instance, in the 2024/2025 tax year, the tax rate on dividend income is just 8.75%, compared to a 20% personal income tax rate on earnings between £12,570 and £50,270.

This difference can amount to substantial savings. There are plenty of other tax savings that differ between limited companies and sole trader, such as pension contributions and lower tax rates on the money left over in your limited company when you close.

3. Cost, Admin & Complexity

Setting-up as a sole trader is free and fast. You can register as a sole trader and file your yearly accounts yourself on HMRC’s own website, so there's less complexity and admin.

However, limited companies are a bit different. HMRC requires limited companies to keep detailed records and submit annual accounts for the business, confirmation statements and also your own personal tax return, as a minimum. There can also be other requirements, such as filing payroll and VAT returns, dependent on your circumstances.

Because of this complexity, most people use accountants to look after their accounts for them. 'Traditional accountancy firms' typically charge around £800 to £1,500+ a year. However, with  Mighty, our costs are £480 + VAT per year, and our platform also helps with a lot of the admin, from bank feeds and auto-categorisations through to HMRC-filings.

4. Flexibility

In terms of flexibility, operating as a sole trader has its advantages. You can cease trading at no cost, whereas with a limited company, the process can be more complicated.

For example, closing a limited company if you have operated through it previously will require more work to close, as you'll need to file final accounts and close the company, which can be more complicated and cost more. This is worth factoring in if you are offered a short-term assignment (e.g. 3 months), as if you don't intend to use the limited company after this, working as a sole trader may be more beneficial (or as PAYE/via an umbrella company).

5. Credibility

Rightly or wrongly, limited companies are often perceived as more professional and successful than sole traders. Many customers and suppliers prefer to engage exclusively with limited companies, making this an essential consideration depending on your target audience.

This is far more common than you may think, especially if you’re selling services to other businesses. Therefore, depending on your customers and suppliers, being a limited company for this reason alone can be a critical consideration. 

Conclusion

In summary, if you predict annual profits over £50,000, operating as a limited company is likely to be the better choice for you. Even below this, there are circumstances where this still might be the more tax efficient route, such as if you have income elsewhere. It might be slightly more costly, but it can be a small price to pay when considering the potential tax savings and protection of your personal assets.

What Next?

If you'd like to discuss this topic further, we offer a free consultation to advise on the best route for you as well as a demo of the Mighty platform.

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