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Sole trader vs limited company: Which Should I Choose?

Lucy Miller 14th Jun 2020 2 Comments

Reading Time: 5 minutes

If you’re taking on freelance work or thinking about becoming self-employed, there are lots of things that you’ll need to think about. One of the first is working out the pros and cons of becoming a sole trader vs limited company. 

There are differences between the two, although they might not always be immediately clear. We’ve looked into some of the things you need to think about if you’re considering whether being a sole trader or setting up a limited company is right for you… 

What will your earnings and finances look like?

Work out your net profit before deciding sole trader vs limited company options

A lot of the time, people will tell you to work out how much you’ll be earning from your freelance work / new business to determine whether you should set up as a limited company or as a sole trader. 

Obviously, it might be difficult to predict an accurate amount. It would be helpful to have a ballpark figure, though, for your own planning purposes. If you’re working for yourself as a freelancer alongside a full-time job, for example, you’re likely to earn less than running your new venture full-time and relying on it as your sole source of income. 

There is no set amount that you need to earn in order to set up as a limited company. However, until you earn a decent net profit, it isn’t tax efficient to run a Ltd company. Some accountants advise that if you expect to earn between £30,000 and £35,000 solely from your business you should consider this route for tax efficiency. 

Working with clients

There is one time in the sole trader vs limited company discussion where businesses with a low net profit should still consider going Ltd.

If you’re going to be looking for outside funding or investment, it’s advisable to set up as a limited company rather than as a sole trader. Most external organisations will expect to deal with limited companies in this case. Some organisations will only work with limited companies. If you’re a sole trader be aware that you might need to set up a company in order to work with certain clients in the future. You may need to register as a Limited Personal Services Company (PSC) if you plan to be a contractor – though this could get difficult with the introduction of IR35 tax laws in the private sector.

Registering as a sole trader vs registering as a limited company 

It’s important to note that you do not need to officially register to “become” a sole trader. This happens automatically when you register for self-assessment, which you can do on the Government’s website. This informs HMRC that you’re now self-employed. Remember, you must still do this even if you’re just freelancing on the side, or are on payroll elsewhere. It’s important to inform HMRC in this way (or by phone, of course) by the 5th October in your business’s second tax year. 

You can move from being a sole trader to running a limited company in the future. You might choose to do this if the amount of money you’re bringing in increases or you start to bring on staff. This isn’t a difficult change to make. 

If you want to run a limited company, you will have to register with Companies House and file various pieces of information with both them and HMRC every year. More on that below.  

Tax and admin differences between sole traders and Ltd companies 

If you set up as a limited company you’ll have more admin than if you remain a sole trader. As a sole trader, you’ll need to do the following:

  • Set aside money for tax every time you’re paid
  • File a self-assessment every year
  • Sometimes make a “payment on account
  • Pay your tax bill via HMRC by January 31st.

This sounds like a lot. Once you’ve got your head around the process, though, you’ll find that it’s quite straightforward. 

There is more admin to make sure you’re on top of if you’re the director of a limited company, including the initial registration via Companies House (see above). You’ll also need to:

  • Submit accounts to both Companies House and HMRC
  • File your Confirmation Statement, P60 and CT600 form once a year
  • Pay National Insurance and corporation tax.  

Despite the extra admin, it can be more efficient to be a limited company rather than a sole trader. This is because you pay corporation tax rather than income tax, meaning you will only pay tax on your profits, rather than on your entire income. 

Whichever company structure you choose, consider hiring an accountant to help. You can write their fees off your taxes, and they could help you save hundreds or even thousands of pounds a year.

Personal liability 

One benefit of becoming a limited company is that your business is a separate entity from yourself. This means that your personal assets, such as your home, are protected if the business falls into debt.

This isn’t the case if you’re a sole trader. In this case, if your business makes a loss you’re personally responsible for it. It means that if your company is going to be investing a lot of money, employing staff, or taking financial risks, becoming a limited company is the best way to go. 

Issues with limited companies 

It’s worth noting that directors of limited companies have had trouble accessing financial support during the recent coronavirus crisis, as one of the only groups that the government ignored in providing financial grants. The Self-Employed Income Support Scheme (SEISS) has provided grants for sole traders, but some have said that this is not enough. Limited company directors technically qualified for the furlough scheme instead. However, as they pay themselves a small PAYE salary and make the rest of their income from dividends, the amount available through the furlough scheme was minimal. It also meant Ltd directors could not work for their company while they were furloughed (except for essential work as a director – but no revenue-generating work).

Should a recurrence of the lockdown occur, with businesses forced to halt their work for a second time, the owners of newly-registered limited companies should be aware that they might encounter similar problems.

It’s also been implied that self-employed people might face higher taxes in the future in order to pay back the shortfall caused by the crisis. Those considering setting up limited companies should be prepared for their taxes to potentially go up in the future. 

You should also be aware of IR35, the changes to off-payroll working rules. IR35 was supposed to come in in April 2020, but was postponed due to coronavirus. It is expected to be introduced in 2021.

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4 years ago

tax and liability are the main differences.

4 years ago

Really informative article. Much better than the information available on government web sites.

Jasmine Birtles

Your money-making expert. Financial journalist, TV and radio personality.

Jasmine Birtles

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