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Starting a business: sole trader versus limited company?

sole-trader-versus-limited-companyDuring these uncertain economic times, many people are viewing this as a good opportunity to start a business.  However, as accountants we often get asked the sole trader versus limited company question.

Firstly let’s go through the definitions:

A sole trader is when there is no separate legal distinction between you and your business.  As a sole trader, you must pay income tax and national insurance contributions on your business profits regardless of drawing levels.

A limited company is a separate legal entity.  Although you will be the main and perhaps only shareholder in the business, you will serve the company as a director.  The company pays corporation tax on its profits, and you will pay further tax should you withdraw these profits from the business in the form of dividends or salary.

With the definitions dealt with you may be thinking which one is right for you.  In making this decision you should consider the following:

Insolvency: as a sole trader if the business fails, you will be personally liable for all its debts and this could potentially lead to you becoming bankrupt.  As a shareholder in a limited liability company, you would not be personally liable for any of the company’s debts, other than up to the value of your investment.

Accounts: as a sole trader you only have to prepare accounts in a basic format (unless VAT registered), whereas a limited liability company must prepare full accounts in accordance with The Companies Act and HMRC requirements.  As a result of this the administration and accounting costs of running a limited company is higher than for a sole trader.

Paying yourself: as sole trader, regardless of your drawings from the business, these will be ignored when computing business profits, which will be taxed at the full income tax rates on top of which you will have national insurance contributions to pay.  By operating through a limited company, you can combine a director’s salary with dividends.  Careful tax planning here can ensure a limited company owner makes a significant tax saving.

Expenses: both operating as a sole trader or through a limited company, allows you to obtain tax relief for expenses that are incurred wholly and exclusively for the purposes of your trade.

General Rule: With the sole trader versus limited company question, it is often a rule of thumb among accountants if you earn more than £25,000 and will be in business for longer than 3 months a limited company is the best option for you.

Each individual case is different and we suggest you seek professional advice of a qualified accountant who can tailor the right solution for you.

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About Hardeep Mangat

Hardeep is a down to earth accountant, who loves helping contractors, freelancers and small businesses save tax and make more profit. He also has a particular interest in IR35 . Hardeep attended University College London and is a Chartered Certified Accountant, who previously worked for Credit Suisse Investment bank and at a local accountancy practice.

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