Not sure what to do? Registering as a Limited Company can be more beneficial with tax advantages when compared to being a Sole Trader
Updated July 2016.
Over the years, many of our clients have come to us and asked if they should change from being a sole trader into becoming a fully-fledged Limited Company. Our advice in these circumstances is that it all depends on the type of business you run, how much you are turning over and whether you plan to grow and expand business further. These questions are vitally important to help answer that all important question.
There are a lot of differences between being a sole trader and a Limited Company. Let’s take a look at how tax is affected under each circumstance.
What are the tax differences between a Limited Company and a Sole Trader?
If you are self employed, and trading as a sole trader, your business profits and personal income are lumped together under the same roof. This means your income is taxed via the annual self-assessment process. You will not be able to defer profits to other years, so if you have a good year with a high turnover followed by a slower year with less profit, you cannot carry over any profit from the previous (good) year to see you through a lean year (share dividends can be held back). In addition to personal income tax you are required to pay National Insurance Contributions (NIC) on all your profits.
If you run a Limited Company and are a shareholder, the company is liable for Corporation Tax on the business profits. The advantages of a Limited Company is that you will be able to hold back profits and then distribute them as dividends in future years. This means you can maximise the tax efficiency and utilise all the tax breaks afforded to Limited Companies. Simply put, you are likely to pay less personal tax than being a sole trader.
The main benefits of forming a Limited Company when compared to a sole trader:
- An obvious benefit is that the Limited Company is a separate legal entity from you in the eyes of the law and protects you and your personal assets from legal disputes. You are not liable personally, so if the worst should happen and you have to cease trading and close your business, you will not have to pay off any company debts with your own personal money, unless something like fraud or money laundering has taken place. However, a sole trader will be responsible for any outstanding debts left behind, and if they find themselves in a legal battle will be susceptible to losing personal assets if found guilty.
- Limited Companies can be more tax efficient as a dividend has a lower flat rate of tax when compared to higher income tax bands. So a Limited Company owner can pay themselves in dividends, and ultimately pay less tax when compared to a high earning sole trader who could find themselves paying upward of 40% income tax on earnings.
- If you expect your business to earn very little, a sole trader would be easier to manage, a Limited Company can often require the help of an accountant to ensure the correct workings of the company tax liabilities.
Professional Business Image
Many companies are only happy doing business with a registered company. Being a limited company can give you a more professional image and encourage more businesses to trust you and do business with you.
Your trading name will also be protected as a limited company. When you go through the formation process, your company name will be filed with Companies House and no one else will be allowed to trade under your business name. This can be a great bonus while you are still growing your business and crafting a strong reputation for your company. You wouldn’t want all your hard work and effort to build your company branding and credibility to go to waste through someone else stealing your trading name.
If you are unsure what you require or what is the best option is for you, please contact us so we can talk through the best options for you and the future success of your business.
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