While being a sole trader is the most popular choice when setting up in business, turning it into a limited company can have advantages.
There are approximately 3.5 million sole traders in the UK, according to figures in 2019, making the sole proprietorship legal structure the most popular.
Limited companies make up 1.9 million businesses in the country, which means it’s the second most popular structure.
And while the sole trader route may be the most popular, there are times when becoming limited could help.
It’s a question we’re often asked when clients who are sole traders visit our accountancy practice in Newcastle.
What does limited mean?
The name means you have limited liability. You’ll often know that you’re dealing with a limited company as they usually have ‘Ltd’ after its name.
Such a company is, in the eyes of the law, a separate entity to the owner. If you are the only person in the business, you will be classed as an employee.
While some sole traders may feel doing this means they are losing control, there are good reasons for going limited. As we’ve mentioned it means the use of the word limited means ‘limited liability’.
So, if you have business debts as a sole trader or your business goes bust your personal finances and assets are in danger.
Being limited means you are an employee your personal assets and finances are protected should there be a problem with the business.
But be aware that if you apply for some loans, banks can often ask for security from the company’s directors, and that often includes your house!
As well as your finances, consider legal disputes. In the (hopefully) unlikely event of legal action, the company faces the issue, not you. Sole traders face action personally!
One major advantage is that it’s a more tax-efficient way than sole traders.
This is because a limited company owner and directors can pay themselves dividends instead of a salary.
That means they pay dividend tax, which is lower than income tax. Sole traders, however, have to pay tax on all profits above their personal tax allowance of £12,500.
Dividend changes in 2016 mean that the differences are not as large as they used to be, however. Being paid dividends means some people are finding it difficult to access coronavirus support.
Your company will also pay corporation tax on its profits, too.
One of the disadvantages is that the amount of paperwork increases!
Sole traders only have to file their annual self-assessment tax returns, whereas limited company owners must:
- Prepare annual accounts and file them with Companies House.
- File full corporation tax accounts for HMRC.
- In theory, file your company’s accounts on your own, it’s best to use a limited company accountant.
Although some limited companies are effectively sole traders, having the ‘Ltd’ on your business name can appear more professional.
Some businesses, contractors and potential clients may prefer to work with you as a limited company as their perception is you are more professional.
Knowing you are a limited liability company can make people feel more comfortable to work with you. They can also access your business information at Companies House, which may make them happier if they can see your accounts before offering credit.
There are advantages and disadvantages to both structures, so if you are unsure, why not contact us today to discuss your options.