When it comes to going self-employed, one of the first big decisions you’ll need to make is whether you should set up as a sole trader or a limited company. Both structures have their pros and cons, of course, and you may even find that you’ll operate within either over the course of your business life. 

Whether you’re just starting out, or whether you’re simply considering setting up a limited company, we’ve put together this simple guide to what each of these business structures are, their main benefits, and their tax responsibilities.

What is a sole trader?

Sole traders run their own self-employed business as an individual (or sometimes a partnership). Once you’ve claimed all your expenses and paid tax on your business profit through your annual self-assessment tax return, you can keep what remains for yourself. 

As a sole trader, you’re personally responsible for any losses your business incurs. You’ll also be responsible for filing your annual Self Assessment Tax return, and paying any Income Tax or National Insurance Contributions (NICs) you owe on your business profit. You may have other information to submit to HMRC as well, such as VAT if you’re registered, either voluntarily, or if your business turnover is above the VAT threshold.

What are the benefits of being a sole trader?

There are a number of benefits to being a sole trader, including:

Less paperwork – limited companies need to submit extra paperwork to HMRC and Companies House (Corporation Tax, Annual Accounts, VAT returns if VAT registered) on top of their annual Self Assessment. Sole traders don’t!

Simpler accounts – the accounting process is much simpler for sole traders. There’s less paperwork and potentially fewer expenses to account for.

Privacy – legally, limited companies must share certain information with the public, such as stating the names of directors and shareholders on public registers at Companies House. As a sole trader, you don’t have to have any of this information publicly available.

For more information on what a sole trader is, the main advantages and disadvantages, and a breakdown of the taxes you’ll need to pay, check out our “What is a sole trader?” article.

What is a limited company?

A limited company is a legal structure for a business, where the company is its own separate entity, even if you’re the only director and shareholder. The limited part of the name refers to the fact that, if something goes wrong financially, your liability is usually limited to the amount you paid for your company shares, coupled with any unsecured loans made to the company. So, if the company runs into financial difficulties, you won’t be personally liable for any of its losses.

If you decided to set up a limited company, you’ll take on the role of a limited company director: you’ll be responsible for any legal and financial decisions the company makes, but the company’s assets and liabilities are completely separate from your own personal finances. 

You’ll have a number of director’s responsibilities – you’ll need to make sure you file a Confirmation Statement and Statutory Accounts each year with Companies House. You’ll also need to file various returns with HMRC, as well as paying any Corporation Tax, VAT or employment taxes the business owes. If you are paid a salary or dividends, these need to be included on your annual Self Assessment tax return. 

When you set up a limited company, you’ll also become a shareholder of your new business. You can be paid a salary (much like an employee is), which counts as a business expense, and also in dividends from the company’s available profit after accounting for Corporation Tax. This combination of salary and dividends can be used to maximise your tax efficiency, which can often result in you paying less tax than you would as a sole trader.

What are the benefits of being a limited company?

There are also a number of benefits to becoming a limited company, including:

Limited liability – as the company is a separate legal entity, your personal assets are protected. If your company needs to close or experiences financial difficulties, your personal assets cannot be taken from you to pay company debts.

Potential for greater profitability – by paying yourself through a combination of dividends and salary, you can reduce your income tax and National Insurance liabilities.

Borrowing power – as a sole trader, you rely on your personal credit rating to borrow capital used to grow your business. A limited company can establish its own credit rating, which can support borrowing to invest in the business.

Improved credibility – some clients simply prefer to work with limited companies, others flatly refuse to deal with unincorporated business. So, having a limited company can present new business opportunities that may not otherwise have existed.

We’ve got plenty of additional articles to help you decide whether a limited company is the right move for you, including our “What is a limited company?” article and our “What are the main advantages of a limited company?” article.

And remember, if you are interested in registering a limited company or setting up as a sole trader, here at Companies Made Simple, we can help!