Should you be a sole trader or a limited company?

Sole trader or limited company – it’s the decision that the majority of entrepreneurs face when starting a business.  So what one should you choose? This guide breaks down the differences for you.

What are the differences?

First of all, let’s break down the differences between being a sole trader and a limited company.

Sole trader

Most small business owners feel at times that they ARE their business – and if you’re registering as a sole trader, you’d be right from a legal point of view too. Registering as a small business means you have complete control, whether or not you employ others, and that you keep all of your profits after tax. Rather than paying corporation tax and taking a salary, the profits are your salary, and you’re taxed accordingly – just like any other income.

Because legally there’s no separation between you and your business, being a sole trader also means that in the unfortunate case that you run into difficulties, you’re completely responsible. However, it’s a much easier process to get set up – in fact you can hop online and do it in a few minutes.

Limited company

By registering your business as a limited company, you create an independent entity that you work for (even if you’re the founder). So rather than taking the profits as your wages, they belong to the company, and you take a salary – you’re technically an employee. Any money you take from the business is either salary, dividends, or a loan.

Why do this? Well from a tax perspective it can be beneficial, as you’re paid as an employee and also have the option to become a shareholder (entitling you to dividends). And as noted above, when you’re a sole trader you’re liable for anything that goes wrong with the business – but if it’s a limited company, your assets are protected more.

However it’s a more complicated process than simply registering as a sole trader, and you’ll have to pay a fee.

Which option is right for me?

It depends on what your plans for the business are, and what stage you’re at. Let’s look at two different examples.

You’ve recently started making your own clothing and handicrafts and selling them at markets and on Etsy in your spare time. Your turnover is low and you have another job.

In this scenario, registering as a sole trader would be most beneficial at this stage. It’s quicker, easier, and more tax-friendly. When you’re just starting out, being a sole trader can be a good way to get going – you can always register as a limited company afterwards.

You’ve been running your own PR agency for a year now as a sole trader, but you’re hiring new staff and moving premises. While your turnover is increasing significantly from when you started out, to expand you’re taking out a loan on your house, and you’re concerned about risk.

In this case, registering as a limited company would be most beneficial at this stage. It lessens the risk of losing your home should anything go wrong, and you might be reaching a point where paying corporation tax and taking a salary is more beneficial tax-wise than your profits being subject to income tax.

How do I do it?

For registering as a sole trader, it couldn’t be more simple. Simply register your details here. But don’t forget that you should register by 5th October following the end of the tax year that you need to send a tax return for.

As we’ve mentioned earlier, registering your business as a limited company can be tricky and time-consuming, so if you’re unsure about what step you need to take it’s worth consulting a solicitor or accountant – it could save you money and heartache in the long term. There are also online registration companies and formation agencies that can speed up the process, or make it easier.

Companies House is the best place to start if you’re looking at registering as a limited company. This is also where you’ll file your details.

When registering your company, you can either buy a ready-made company name, or you can form a brand new company. Forming a brand new company requires a memorandum of association (a form detailing the company’s name, registered office and nature of business, which needs to be signed by the company director in front of a witness), articles of association (which detail the rules ad running of the company), and a completed IN01 form. These can be gotten from a legal stationer or from a company-formation agency. (Still with us?)

You’ll also need to appoint at least one company director, who must be over 16 years old. They also cannot be company director if they are an undischarged bankrupt, or if they have been disqualified from directing a previous company.

Good luck!

Image source: Flickr Creative Commons