One of the first tasks you will have when starting up your business will be to decide whether to set up a new limited company, or become self-employed. If you choose to go self employed, this could be either as a sole trader, or as a partner in a partnership.
The different business structures each have their own advantages and disadvantages, so it’s vital you understand what each offers you. Working out which option best suits you, and your new business, can take a little time but it is an important decision, and one that can have major ramifications over the years ahead, so you do want to choose the business structure that best suits your circumstances.
Here we look at some of the differences between working as self employed and setting up a limited company;
How are sole traders and limited companies taxed?
If you are self employed (as a sole trader, or a member of an unincorporated partnership), your business profits and other personal income is taxed via the annual self assessment process. You cannot defer profits to future years.
For the 2016-17 tax year, the personal allowance is £11,000 – you pay no income tax on this amount. You pay income tax at 20, 40, or 45%, depending on your annual profits.
In addition, you must pay National Insurance Contributions (NICs) on your profits. Class 2 NICs are £2.80 per week (2016/17 tax year), and HMRC will calculate your Class 4 NICs on your annual profits.
You can find out more in our sole trader tax guide.
Limited companies are liable for Corporation Tax on their business profits. The Corporation tax rate is currently 20% (2016/17 tax year).
Unlike the sole trader route, a limited company can retain profits and distribute them as dividends in future tax years if necessary. The directors may wish to delay paying income tax on dividends during a good year, and defer paying dividends to the following tax year.
You can find our more in our corporation tax guide.
For the latest tax tables, rates and allowances, visit our tax rate section.
What are the benefits of incorporating vs becoming a sole trader?
- One of the main benefits of working via a limited company is that your personal and business finances are distinct, so if a claim is made against your company, you will not be liable personally (assuming nothing illegal has taken place).
- Under the sole trader route, if a financial claim is made against your business, your own personal finances may also be included in any settlement.
- Setting up as a sole trader is a very simple process. All you need to do is inform HMRC of your intention to go self employed, you can start trading right away.
- Limited company directors, on the other hand, have to deal with more paperwork, and have various legal and statutory obligations. Limited companies are regulated by Companies House, and directors are ultimately responsible for providing accurate and timely accounts on an annual basis, even if your accountant does the actual work.
- Tax-wise, limited company directors have the potential to pay less tax, as they can pay themselves small salaries and high dividends which are free from National Insurance, whereas sole traders pay themselves a salary which is liable for NICs as well as income tax.
There is no right or wrong business structure, just the one that suits your individual situation. Once you have an understanding of the main benefits of each option, you can make an informed decision. The route you choose is very much up to you.
If you start out as a sole trader, and later on wish to form a limited company, it is possible to do so.
More about sole traders and limited companies
For more help on the subject, it’s well worth reading the following guides;
- 5 things you must do when you go self employed
- 10 advantages of running your business as a limited company over being a sole trader
- Why it’s important you plan your exit strategy before you start your business
- The responsibilities of a company director
- How to set up a limited company
Whatever you decide to do, we always recommend you discuss your situation with an accountant or business adviser before going ahead.
More on starting and running your own business
ByteStart is packed with help and tips on all aspects of starting and running a small business. Check out some of our most popular guides;
- How to choose the best online accounting software for your business
- 15 Questions to ask when hiring an accountant for your new business
- How to create your own startup support team and boost your chances of success
- 10 Do’s and Don’ts of writing a business plan
- Get your business noticed! – Marketing tips for startups
Funding your business
- How to maximise your chances of securing a small business loan
- A Guide to ‘Alternative Finance’ – the new funding options for startups and small businesses
- Finding finance for your new business – funding advice for start-ups
- How peer-to-peer lending offers businesses a new funding option
- What to do when the bank says “NO”!
Money & Tax matters
- 10 ways small business owners can pay less tax
- Sole trader tax – a guide for start-ups and the newly self employed
- Dividend tax changes from April 2016 – A summary of the financial effects for small business owners
- ByteStart’s Guide to the main business taxes
- Corporation Tax – How to reduce your bill
Promoting your business
- Making your small business a BIG hit online – A Digital marketing guide for small business owners
- How to create business cards that make a big impression
- The “Magic 10” Tips on networking – how the experts build great networks
- How to attract customers from heaven – not clients from hell!
- 10 Top tips for small businesses starting out with social media
- Which types of insurance must your business have?
- Becoming an employer – Your responsibilities when you hire staff
- Health & Safety compliance for small businesses – where do you start?
- A Guide to the National Living Wage for small business owners
- Why it’s vital you have clear ‘Terms & Conditions’ for your business