Should I Be a Sole Trader or Set Up a Limited Company?

Choosing the right business structure is a crucial decision for any entrepreneur. The two most common options in the UK are operating as a sole trader or setting up a limited company. Which to choose is a very common question we get. However, there is a lot involved in both, and it is certainly not a case of one size fits all anymore.

Each has its own set of advantages, disadvantages, and tax implications, which can significantly impact your business. We have looked at two examples for profits of £30,000 and £60,000 for both a sole trader and limited company structure and the different taxes and rates that apply. This article will help you understand the differences and guide you in making an informed decision.

Sole Trader

As a sole trader, you are the sole owner of your business. This structure is straightforward to set up and involves less administrative burden. You and your business are one and the same. All profit made after tax is yours. However, the simplicity comes with some drawbacks, particularly concerning liability and taxation.

Advantages

• Simplicity: Setting up as a sole trader is quick and easy. There are fewer administrative requirements and less paperwork.  You need to register with HMRC as self-employed and complete the tax return to declare a profit (and pay tax) or loss.
• Control: You have complete control over your business decisions and profits.
• Privacy: Financial records remain private, unlike limited companies, which must file annual accounts with Companies House.

Disadvantages

• Unlimited Liability: You are personally liable for any business debts. This means your personal assets could be at risk if your business encounters financial difficulties.
• Taxation: Sole traders pay Income Tax on their profits, along with National Insurance contributions. This can become less tax-efficient as profits increase.

 

Tax Implications for a Sole Trader

Let’s look at two profit levels and see what the tax implications are on both of these:

£30,000 Profit

Income Tax: Personal Allowance (£12,570) + Basic Rate (20%) on remaining £17,430

Class 2 National Insurance: £3.45 per week. Please note that as of 6th April 2024 Class 2 is no longer required but you may wish to make voluntary payments if your profit is low.

Class 4 National Insurance: For the 23/24 tax year the rate is 9%, for the 24/25 tax year this drops to 6% on profits between £12,570 and £50,270. This is subject to change at the will of the government, as is the case with the all tax.

£60,000 Profit

Income Tax: Personal Allowance (£12,570) + Basic Rate (20%) on next £37,700 + Higher Rate (40%) on remaining £9,730

Class 2 National Insurance:** £3.45 per week for a 23/24 tax return but not after the 23/24 tax year.

Class 4 National Insurance: 9% on £37,700 for the 23/24 tax year and then 2% on £9,730 (higher level rate).  The rate drops to 6% for the basic rate tax payer in 24/25, the upper profits limit is still 2%.

Limited Company

A limited company is a separate legal entity from its owners, offering more protection and potential tax benefits. However, it involves more administrative work and regulations.

Advantages

• Limited Liability: Shareholders’ personal assets are protected; they are only liable for the company’s debts up to the amount they invested.
• Tax Efficiency: There are more opportunities for tax planning, such as dividends.
• Professional Image: Operating as a limited company can enhance your business’s credibility and professionalism.

 

Disadvantages

• Complexity: Setting up and running a limited company involves more paperwork, regulatory requirements, and administrative tasks.
• Public Records: Financial records and accounts must be filed with Companies House and are publicly accessible.
• Costs: There are costs associated with incorporation, annual filings, and potentially higher accountancy fees.

Tax Implications for Limited Companies

£30,000 Profit

Corporation Tax 19% on profits

Dividends (if taken): £30,000 profit – £5,700 Corporation Tax = £24,300 distributable profit. Dividend Allowance (£1,000 for the 23/14 tax year and then £500 for the 24/25 tax year) + Basic Rate (8.75%) on remaining £23,800

Director’s Salary: A small salary can be taken, which is usually below the National Insurance threshold. A salary is a taxable expense and so will reduce corporation tax.

£60,000 Profit

Corporation Tax: The government introduced a new tax rate of 25% for company profits over £50,000. There is marginal relief for profits between £50,000 – £250,000 with the calculation taking where the profits fall in that bracket into account. Corporation tax on £60,000 profits are £12,150.

Dividends (if taken): £60,000 profit – £12,150 Corporation Tax. This leaves £47,850 in distributable profit.

Dividend Allowance (£500) + Basic Rate (8.75%) on the remaining £47,350

Director’s Salary: A small salary can be taken, which is usually below the National Insurance threshold. I have assumed this has been taken and the personal allowance has been used up for the personal tax element.

Conclusion

Deciding whether to operate as a sole trader or set up a limited company depends on various factors, including the size and nature of your business, your profit levels,  long-term goals and any other income.

For profits of £30,000, the tax savings are with the sole trader. For profits of £60,000 the tax efficiency of a limited company becomes more marginal, potentially making it a better option despite the increased administrative burden.

It’s essential to consider your specific circumstances to determine the best structure for your business. We always advise clients to look at the long-term goal of the business and think about the broader picture. As we have seen, the tax landscape can change rapidly, so a decision about company structure can no longer depend on tax savings alone. You need to consider the potential to grow, what kind of liability you want to take on, and a number of other factors.

We’ve purposefully not added all the tax figures into the above, as it’s worth running the calculations for yourself with your own numbers. The rates, allowances, and bands do change, so the tax year you are looking at is likely to have different rates applied to it, resulting in different figures and savings. This is another reason tax saving should not be the leading factor in your company’s structure decisions.

There are many other reasons why a limited company may suit one business better and why a sole trader business may be more beneficial for another.

If you want to talk through the pros and cons feel free to give us a call.  We can offer our knowledge and support as you navigate the intricate and sometimes fun world of taxes.  Always remember to keep one foot on solid ground (taxes are a moving landscape) and remember the end goal for you and your business. This will give you a good indication of the best way forward.