Sole trader v limited company


Simon Misiewicz

1st March 2021

The frequently asked questions about sole trader v limited company

Income tax: You may be interested in our main Article on Self-assessment tax returns or our other Article where we focus our efforts on how much income tax you need to pay to HMRC. You may also be interested to know more about our tax-saving services for UK landlords and property developers.

Limited Company: You may be interested in our main Article on Limited companies and tax structures. You may also be interested to know more about our property tax services to help you buy and rent residential properties in a more tax-efficient way.

As accountants, we are regularly asked about sole trader v limited company by landlords. We will look to answer the questions below in this Article.

“Is your business paying too much tax?”
“What are the basics of sole trader and limited company structures?”
“Which is more tax-efficient: sole trader or limited company?”
“What are the pros and cons of being a sole trader business?”
“What are the benefits of using a limited company as a investor?”
“Can I switch from being a sole trader to a limited company?”
“What’s the difference between being a sole trader and self-employed?”
“Do I need an accountant for a limited company business?”
“How does this affect our American readers?”

Is your business paying too much tax?

Our tax specialists help over 1,000 monthly retained clients minimise tax whilst building their wealth.

One of the first steps in helping to make a business more tax-efficient is to set up the most appropriate structure. This can be as a sole trader, limited company, or limited liability partnership.

There are many reasons why landlords pay far more tax than they need to from their business. This is because:

– They do not know what they do not know.

– They have not spoken to a tax specialist to go through their situation to see what available tax reliefs are available to them.
– Their accountants or solicitor are not aware of the many reliefs that are available to their clients and are not taken advantage of.
– Tax legislation changes but either the person or their accountant/tax specialist has not been made aware.
– They do not have a tax-efficient business structure in place.

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What are the basics of sole trader and limited company structures?

There are three main forms a business can be set up.

– Sole trader
– Limited company
– limited liability partnership.

According to Government statistics, sole traders are the most popular company structure, with 3.5 million sole trader businesses being active at the start of 2020.

Sole trader businesses form 59% of the total incorporated companies established in the UK, with 2 million limited companies and 414,000 active company partnerships.

Business owners need to weigh up the advantages and disadvantages of sole trader and limited company structures to gain the best tax benefits available.

Self-assessment registration for business owners (sole traders)

You must set up as a sole trader if you earned more than £1,000 during the previous tax year. It would be best if you told the HMRC that you pay tax through self-assessment.

self-assessment tax return will need to be filed annually, and you will need to register for self-assessment with HMRC to do this.

As a sole trader, you can keep all of the business’s profits after you’ve paid tax on them. You are also personally responsible for any business losses you make.

A sole trader business in the UK must keep records of sales and expenses and send a self-assessment tax return every year.

Sole Trader taxation involves submitting a self-assessment tax return every year. Each tax year ends on 5th April, with payment being due to HMRC by 31st January the following year.

Higher tax bands are applied depending on how much money a sole trader makes with tax due on taxable income.

A sole trader will also need to consider if they need to make a payment on account, whereby they pay an additional 50% of their tax due simultaneously as they pay their previous tax bill on 31st January.

Sole traders must pay income tax on profits and also Class 2 and Class 4 National Insurance contributions.

A sole trader business cannot include ‘limited’ ‘ltd’ ‘limited liability partnership’ ‘public limited company’ or ‘plc’ in the business name.

A sole trader business name cannot be the same as an existing trademark and should not suggest a connection with government or local authorities unless permission is given.

Business owners using a limited company tax structure

Risk mitigation is a key factor why so many business owners use a limited company in addition to certain income tax and inheritance tax benefits of using a limited company.

limited company is a business structure that has its own legal entity. This is completely separate from shareholders and directors. This is the case even if a limited company is run by a single person acting as shareholder and director.

Legal responsibilities are the limited company’s responsibility and not the people associated with its running.

– Debts arising from a limited company’s operation would be the business’s responsibility and not the individuals involved.
– Personal assets remain safe from any court action that creditors might take.

There are certain tax advantages of running a business as a limited company which will be explored later in this Article.

Which is more tax-efficient: sole trader or limited company?

When talking to our UK and international clients, we establish their current company structure to see if their business is paying too much tax.

It will be common that business owners get in touch with us whilst operating as a sole trader but worry about the amount of tax they may pay in the future. This is especially the case when they make more money each year.

They are considering changing their business as a limited company instead of saving tax but are unsure if it is the way forward. This question is not easily answered because:

– We do not know how much money they have in their personal name other than their business activities.
– We do not know how much money they would like to extract from their business activities for personal use.

We know that people want quick answers. We think it is a mistake to rush a decision that you will use for many years to come. That is why we have a databank of questions to ask clients what they want now and in the future to establish a tax structure that is not just suitable now but for the next ten years.

Have a question about property investments, tax or being an expat?

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Double taxation issues when using a limited company

Firstly, through corporation tax payment due to HMRC annually. The business owners would then be subject to income tax from any money an individual withdraws from the limited company as taxable earnings.

On the positive side, the tax rate for a limited company remains at 19% irrespective of the profit made. A sole trader pays higher tax bands at different levels of income earned.

When it comes to running your business in the most tax-efficient way, we can help.

From the diagram below, the three main elements to consider with setting up a limited company for your business are

When we compare taxes using a self-assessment v limited company diagram below, the tax advantages of having a business in a limited company are clear.

I hope you can see from the above that you need to establish how much business profits you expect to earn. Once you have established how much profits you will make, it is our turn to work out the future tax you will need to pay.

The information obtained from above will help you discuss with us to work out the very best tax structure for you.

What are the pros and cons of being a sole trader business?

Sole trader businesses are simple to set up with only a small amount of paperwork. This includes an annual self-assessment tax return.

There is also a much higher level of commercial privacy for sole traders. Incorporated businesses must file annual accounts, which can be viewed within the public domain at Companies House.

Sole traders have unlimited liability as their business is not seen as a separate entity by UK law.

This means the business owner is personally liable for business debts and may lose personal assets to pay debts.

It is possible that raising finance can be more difficult, as banks and other financial institutions or investment sources can view a limited company business as more stable.

Tax rates for sole traders can be prohibitive at higher profit levels compared to limited companies. Getting the right tax advice is critical.

What are the benefits of using a limited company as a business owner?

Using a limited company as a tax structure gives business owners a legal distinction between them and their business. This protects their personal assets as liabilities are limited to their business, not them. This provided that the business owner has not provided a ‘personal guarantee’ on the debt.

Limited companies also pay a flat rate of 19% to HMRC. This makes their business tax-efficient when they make higher profits than £50,000.

A wide range of tax-deductible costs and tax allowances are what a limited company can claim against its profits, making it an attractive option for business owners.

Another significant advantage of a limited company for business owners is that nobody else can use the business name once established with Companies House.

Business owners operating within a limited company structure for their business have additional legal responsibilities, also called Director’s Fiduciary Responsibilities.

This includes the legal requirements of a company director of a limited company, including filing a yearly annual return. Limited company directors are also responsible for the filing of annual financial accounts.

Business owners using a limited company structure have additional time and costs to be factored in. This includes dealing with the extra paperwork as well as a financial expert such as an accountant.

The transparency of having a limited company business’s financial performance and profits publicly available at Companies House every year is also not appealing to every business owner.

This is the price to pay for enjoying the benefit of limited liability as a landlord.

Do I need an accountant for a limited company?

If you set up a limited company for your business structure, there is no legal requirement to appoint an accountant, but there are multiple benefits.

How does this affect our American readers?

You might be more tax-efficient using a limited company in the UK, but what about the US. There have been several changes since the 2018 Tax cuts and jobs act.

We saw the introduction of Global Intangible Low Tax Income (GILTI), which prevents Americans from benefitting from low-taxed countries.

It is one thing to be tax-efficient in the UK or the US; it is another thing to be tax-efficient across the Atlantic.

This is why you need to get a tax advisor that truly understands international tax.

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