Sole Trader or Limited Company: How to Pick the Right Structure for Your Small Business

Starting a small business is always a challenging endeavour. You have to make difficult decisions about your business model, products, customers, marketing, financing, and more. One of the very first big choices you’ll need to make is whether to operate as a sole trader or set up a limited company.

This decision can have major implications in terms of taxes, paperwork, legal protections, and financing options. To help you make the right call, here is an in-depth look at the key differences between being a sole trader versus running a limited company.

Protecting Your Personal Assets

One of the main reasons people opt to set up a limited company is to protect their personal assets from their business liabilities. As a sole trader, you and your business are legally considered one entity. So, if your business runs into debt or gets sued, your house, car, personal bank accounts, and other assets could potentially be seized.

With a limited company, your business exists as a separate legal entity. The company’s finances and liabilities are separate from your personal ones. So, if the business struggles, your personal property generally can’t be touched to settle its debts.

Of course, this protection isn’t absolute. For example, if you commit fraud or recklessly rack up debt in the name of your company, creditors may still be able to go after you personally in some cases. But in general, the corporate structure does limit your liability.

Reducing Your Tax Burden

In the past, limited companies offered clear and substantial tax savings compared to operating as a sole trader. However, recent tax rate changes have narrowed this gap considerably.

There are still some scenarios where going the limited company route can reduce your tax obligations, but the decision is more complicated. As a sole trader, you pay income tax and National Insurance contributions on all your business profits after deducting allowable expenses.

With a limited company, the company itself pays corporation tax on its profits which from 1 April 2023 ranges from 19% to 25% depending on the company’s profits. Then when money is withdrawn from the company, it usually happens through director dividend payments, which are taxed at rates up to 39.35%.

So, for many small businesses, the total tax burden ends up being similar either way. However, with some clever planning, you may still be able to optimise taxes under a limited company model.

For example, you can control when dividends are paid out. So, in years when you are above the higher or additional rate tax thresholds from other income sources, you can choose to leave profits inside the company temporarily and pay dividends later when more favourable tax rates apply to you personally.

Lower Administrative Costs

Running your business through a limited company does involve quite a bit more administrative work. You need to register the company, file annual accounts and tax returns for the company, comply with additional reporting requirements, and keep the company in good standing to avoid being struck off.

An accountant can handle most of this paperwork for you. But their fees for dealing with a company tend to run higher than for basic sole trader accounts.

If you handle the admin yourself, it’s less costly but more time consuming. For some very small businesses or side hustles avoiding these extra hassles can be reason enough to operate as a sole trader.

Additional Tax Deductions 

Depending on your business activities, you may find that some specific tax deductions are only available to limited companies. For example, companies get more flexibility in deducting costs related to business vehicles, employee benefits, staff training programs, and other areas.

However, sole traders also get some deductions that limited company directors can’t claim. For instance, if you work from home, a portion of household bills like gas, electricity, broadband, etc. can potentially be deducted by a sole trader but usually not by a limited company director.

So careful review would be required into what types of costs your business will generate to see if one structure or the other offers noticeably better deduction opportunities.

Hiring Employees

When your business grows to the point of taking on additional staff, a limited company structure often makes more sense. Payrolling employees and accounting for PAYE, National Insurance, pensions auto-enrolment, and other obligations is typically more straightforward through a company.

Operating as a sole trader or ordinary partnership when you have employees also exposes you to more risks. If an employee brings legal action against you or the business, your personal assets are on the line. And if HMRC decides you should have been operating PAYE and paying employer National Insurance contributions for someone you have engaged as self-employed, you could end up with a very large backdated bill.

Again, going limited doesn’t provide bulletproof protection here, but it does create helpful separation between your personal finances and staffing issues that crop up within the business.

Reputation and Credibility

When tendering for work or trying to win over important clients, operating through a properly registered limited company can boost your credibility and make you appear more established. The company provides a structure for branding your products/services consistently across different touch points.

Your official company details are also published on the Companies House register, allowing suppliers, partners, and customers to easily verify your business credentials.

Now this isn’t to say clients won’t work with sole traders too. Many successful consultancies and tradespeople operate just fine on a self-employed basis. But particularly for newer businesses, having that company around your name can help provide an extra degree of legitimacy and professionalism.

Access to Finance

As your business grows, you may need to take out financing to fund expansion plans. Whether it’s a bank loan, equity investment, asset leasing/rental, or other credit facility, lenders and investors typically prefer to put money into a limited company rather than engage with a sole trader.

Having a company signals that you are serious about building an ongoing concern over the long run. Creditors also view financing a company as less risky compared to providing personal loans without that corporate structure in place.

The exception would be something like a personal credit card you use solely for funding very early start-up costs. But for significant, ongoing business financing needs, you will likely find better rates and options if you incorporate.

Flexibility for the Future

Finally, starting off as a sole trader does not mean you are stuck with that business structure forever. If your business grows significantly or you start facing some of the issues described above, you can choose to incorporate down the road.

Likewise, some companies that no longer benefit much from the corporate structure opt to deregister and continue as sole traders or partnerships.

That said, switching back and forth too often can create unnecessary administrative headaches. So do think carefully upfront about which path better matches your long-term plans and vision for the business. But review things periodically and remain open to changing course if you find the pros start to outweigh the cons of your current structure.

Key Takeaways When Deciding Between Sole Trader vs Limited Company

To recap, here are some of the most pivotal factors to keep in mind:

• Limited company status better protects your personal assets from business debts and liabilities
• Clever tax planning may reduce your obligations under a company model, but often taxes end up comparable either way
• Operating as a sole trader involves less paperwork and lower accountancy fees
• Specific expenses may qualify for deductions under one structure but not the other
• Taking on employees exposes you to fewer risks with a company in place
• Financing and investments are easier to obtain for a limited company
• Customers/clients may perceive an incorporated business as more credible
• But you can switch between structures later on if circumstances change

Of course, your specific situation may also be impacted by other considerations I haven’t covered here. Get professional advice if you are still undecided. Some accountants will even offer free initial consultations to small business owners trying to pick the right route.

There are pros and cons on both sides of this decision. Take your time, understand all the implications, and select the model that best fits your risk tolerance, business activities, and goals for future growth. While the choice may seem daunting at first, picking correctly at the outset prevents a lot of headaches further down the road.

For more information contact Ballards LLP at 01905 794 504

Disclaimer. This article has been prepared for information purposes only. Formal professional advice is strongly recommended before making decisions on the topics discussed in this release. No responsibility for any loss to any person acting, or not acting, as a result of this release can be accepted by us, or any person affiliated with us.