Sole trader or limited company: which should you choose?

When starting out on a new business venture, you will face many important decisions. Some will be less straightforward than others, especially if you have no prior experience.Choosing whether you set yourself up as a sole trader or a limited company is one of the biggest decisions you’ll encounter early on. To help you choose, we have set out below the differences between the two. 

Sole trader v limited company

There are a few key differences in how sole traders and limited companies work for you as a business.

Operating as a limited company means you will need to register with Companies House and send corporate tax returns in the future. It also means you and your business are two separate legal entities. 

That means your finances are completely separate from your business’, and your personal assets are safe, even if things go wrong. Only the capital you (and any other shareholders) have invested is at risk.

Sole traders, on the other hand, are synonymous with, and wholly liable for, their business. They have what is known as unlimited liability – meaning that, if the business fails or becomes insolvent, they are personally responsible for paying any debt incurred.

Pros and cons of being a limited company

As mentioned above, one of the biggest advantages of operating as a limited company is the separation of you and your company as legal entities. 

This means that if your company makes a loss, you will have limited liability and won’t usually be personally responsible. The same goes for any shareholders. The reassurance of knowing that your personal assets (outside what you invested in the company) are safe – even if your business incurs debts – can be a significant driver in setting up as a limited company.

Another positive of being a limited company is that you will have the option to pay yourself through a combination of salary and dividends, which may be more tax efficient.

Your business profits will also be taxed at the corporation tax rate of 19% – rising to 25% for some companies from April 2023) – rather than at the income tax rates that apply to sole traders. And, when it comes to exiting your company, if you have other shareholders, you may find them willing to buy you out.

It is important to be aware, though, that setting up as a limited company requires some paperwork and administrative work, and there is also a modest fee to pay. Being registered with Companies House will also mean your accounts and documents will be on public record, so if you are a relatively private person, it may not be the choice for you.

Pros and cons of being a sole trader

If you decide to become a sole trader, you can start trading as soon as you are ready – you will not need to wait until you are registered with Companies House. 

Your paperwork will be reasonably limited, as, once you have registered for self-assessment with HMRC, you will only need to complete a tax return once a year. You will also benefit from privacy as, unlike limited companies, your records won’t be made public.

And, if you are a sole trader, any profit you make (once you’ve met your tax obligations) is yours to keep. 

That being said, being a sole trader can be stressful. Because you and your business are one legal entity, you will be financially responsible if your business makes any losses or incurs debt. This means your personal assets could become vulnerable, so you must make sure you understand and are comfortable taking, that risk.

Being a sole trader, you must pay all your tax via income tax self-assessment – which, depending on your earnings, may mean you pay more than the rate applied to corporation tax and dividends.

There are many moving parts in deciding whether to operate as a limited company or sole trader, so we always recommend sourcing the opinion and advice of a professional.

Get in touch with the team at Libra Wealth Management to discuss your business.

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