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Limited company or sole trader in 2020 - what’s better?

What’s better: setting up a limited company, or being a sole trader? The pros and cons of both

So you’ve taken the plunge and decided to start working for yourself. We wish your cat yoga studio / homemade brownie bakery / phone book recycling business every success! But should you register as a sole trader, or set yourself up as a limited company? There are pros and cons to each, so we put together these insights with a little help from our freelancer community.

Don’t forget! Whether you decide to do business as a sole trader or a limited company, you’ll need to register with HMRC. Tell them hi from us.

What’s the difference between a sole trader and limited company?

A sole trader is a self-employed person who is the single owner of their business. There’s no legal separation between a sole trader business owner, and the business itself. That means you can keep the profits you’ve made after tax, and you’re personally responsible for any losses your business makes.

Sole trader is the most popular type of business in the UK, with 3.5 million registered to date.

A limited company is a separate legal entity from a business owner, and you can set up as a limited company whether you’re a one-person business or you have employees. As a limited company director, you’re responsible for the legal and financial decisions your business makes, but your business’s assets and liabilities are totally separate from your own individual finances. All profits and losses belong to the company, which means you must always act on behalf of the company.

2.0 million businesses in the UK are limited companies.

Setting up as a sole trader – pros and cons

Most freelancers start out as sole traders, due to the low setting up costs, and the relatively small admin load. Yey for less admin! Here are some other advantages:

  • Lower costs. If you set up as a sole trader, you won’t need to hire a solicitor or company formation agent. Accountancy costs can also be cheaper, as there are far less reporting deadlines for sole traders. You also won’t have to pay a registration fee to Companies House, which will save you a sweet £13. Cha-ching.
  • Greater privacy than limited businesses, whose details can be found via Companies House.
  • Minimal paperwork, apart from your annual self assessment tax return.
  • Control. You don’t have to consult with shareholders before you make any decisions about your business. And all post-tax profits are yours to do with as you please.

There are some disadvantages to being a sole trader, namely:

  • Sole traders have unlimited liability. This means that if your business gets into debt, you are personally liable. As such, sole traders could lose personal property or belongings if things go wrong.
  • Raising finance can be tricky, as banks and other lenders tend to prefer limited companies. This could impact your business expansion plans.
  • Tax rates on sole traders aren’t always as forgiving as they are on limited companies. Once you start earning over a certain amount, it might not make sense to continue as a sole trader.

Setting up a limited company – pros and cons

2.0 million small businesses can’t be wrong! So what are the main advantages of setting up a limited company?

  • Limited companies have the benefit of limited liability, because there’s a legal distinction between you and your business. This means that personal assets aren’t at risk – you only stand to lose what you put into the company.
  • Generally speaking, limited companies are more tax efficient than sole traders, as they pay Corporation Tax on their profits rather than higher Income Tax rates. There’s also a wider range of allowances and tax-deductible costs that a limited company can claim against its profits.
  • Once you’ve registered your limited company name nobody else can get their hands on it, unlike sole traders.

Setting up a limited company also has its disadvantages, including:

  • Get ready for some light reading! You’ll need to familiarise yourself with the Director’s Fiduciary Responsibilities, which basically outline what a limited company director must do legally.
  • Running a limited company can be expensive and time-consuming, as you’ll need to either deal with this paperwork yourself, or hire an accountant to handle it for you.
  • Your company details can be found publicly via Companies House, including info on the directors and your company’s earnings. It’s a legal obligation, but you might not appreciate this level of transparency.

When should a sole trader consider going limited?

Starting out as a sole trader allows you more flexibility as your business grows. It’s usually considered the best structure for newbie freelancers, and you can make the move to a limited company as your business grows. But how do you know when it’s the right time for a change?

It’s best to consult with an accountant if you’re thinking about going limited. If your business has been profitable for a while, they can take a look at your earnings and work out whether becoming incorporated could bring that tax bill down a notch or two. If you think changing to a limited business structure could boost your business’ image and get you more work, then that might be your tipping point. Or you might be ready to bring in more company directors, or even shareholders. In which case, you need to become a limited company, stat.

Can you be a sole trader and run a limited company at the same time?

Much like Clark Kent is also Superman (spoiler!), you can be a sole trader whilst also running your own limited company. You can combine different types of employment and income methods without any hassle from HMRC, provided you’ve done your research and registered both businesses accordingly. So if you’re successfully running your own limited company, and you have another great business idea, you don’t have to risk everything to try it out. You’ll be running an empire before you know it!

Okay, so who pays more tax – sole traders or limited companies?

There’s no straight answer to this one, but we admire your focus on the cash money. Currently, limited companies pay a main rate of 19% in Corporation Tax. This will go down to 17% for the year starting 1st April 2020. If you’re a sole trader, you have a tax-free allowance of £12,500, after which the basic Income Tax rate is 20% if you earn between £12,501 and £50,000 and goes all the way up to 45% for incomes of £150,000 and above.

On top of that, limited company owners need to pay tax on dividends and sole traders are responsible for National Insurance contributions, so it’s a bit like comparing apples and oranges. Always check with your accountant before you make the switch from one legal structure to the other, so you never fall behind on whatever tax bill you’re responsible for.

No matter what you choose to be, ANNA Money can provide you with a business current account, instant invoicing, receipt scanner & automated bookkeeping in one app. They will take pain out of your business admin, so that you can focus on what you love!