Limited Company vs Sole Trader – what’s the difference?

If your New Year’s resolution was to take the leap into self-employment, you may be wondering how do you get started, what are your options, and how do you know which route is the right one to take?

In this blog we’ll explore the main differences between a Limited Company and a Sole Trader, to help you decide if it’s the right business structure for you.

First things first – what is a Limited Company?

A limited Company is a type of business structure that’s legally separate from it’s owners (shareholders) and has limited liability. Key features include:

• Shareholders – owners of a Limited Company are called shareholders. They own shares in the company and this represents their ownership stake
• Directors – The company is managed by its directors, who are appointed by the shareholders and are responsible for the day-to-day running of the business and its legal compliance
• It has limited liability – therefore the shareholders are not personally responsible for the company’s debts. Liability is limited to the amount each shareholder has invested in the company, or the nominal value of their shares
• Financial reporting – A limited company is required by law to maintain and file proper accounting records annually with Companies House. This includes an income statement, balance sheet, and other relevant documents
• Tax – Limited Companies are subject to Corporation Tax on their profits, and shareholders are subject to personal income tax on their salary, dividends, or any other benefits they receive from the company
• Tax planning – they’re also able to take advantage of certain tax benefits which are only available to Limited Companies
• Statutory requirements – there are a number of statutory requirements limited companies must complete each year, including general meetings, maintaining a registered office, and notifying Companies House of any changes

What is the difference between a Limited Company and a Sole Trader?

The difference between a Sole Trader and a Limited Company is that a Sole Trader operates as an individual, and bears personal liability for their business’ debts. Key features include:

• As a Sole Trader you’re taxed on your total profits for the tax year, regardless of the amount of income you take from your business. A Limited Company only pays Corporation Tax on their profits, plus personal tax on any money taken from the company (i.e dividends, salary, etc)
• When setting up as a Sole Trader the process is much simpler than forming a Limited Company. There’re less formalities and the process is much quicker, which appeals to lots of self-employed small business owners
• They’re relatively simple to run as your accounts are basic, with few administrative requirements
• Unlike a Limited Company you won’t have shareholders to consult with when making decisions, so you have complete control
• When it comes to tax compliance, what’s required of Sole Traders is much simpler than Limited Companies, which ultimately reduces the filing process as it reduces the time spent on tax admin
• One of the major risks of being a Sole Trader is that you’re personally liable for business debts, which could put your assets at financial risk
• As your business grows you may find you encounter barriers to raising capital, which you’d may not experience if yours was a Limited Company
• As your business grows you may experience higher income tax rates, which will have an overall effect on your take home pay

Now that the main differences between a Limited Company and a Sole Trader have been identified, we’ll take a closer look at what’s involved in being a Sole Trader, to help you decide if it’s the right route for your business to take.

What type of accounts does a Sole Trader need?

You’ll need an income statement and a balance sheet, to give HMRC an insight into your business’ financial health. You’ll be required to inform HMRC that you have began trading, and to also complete the following:

• Pay income tax on all profits and National Insurance Contributions (NICs)
• Register for VAT if your turnover exceeds the VAT threshold
• Complete your annual self-assessment tax return
• Keep records of all contracts, completed works, incoming and outgoings, and all expenses
• Keep a record of any bills you’ve had to pay, or services you’ve needed to use for your business
• If you work within the construction industry you’ll need to register with the Construction Industry Scheme (CIS)

Do Sole Traders need a bank account?

The difference between a Sole Trader and a Limited Company is that unlike a Limited Company, Sole Traders aren’t legally required to have a separate business bank account, so you are able to use whatever account you wish. You may however decide to open a separate account to keep your business and personal accounts apart, as this helps separate which finances are used for what, and helps you keep on top of your business’ incomings and outgoings.

Do Sole Traders need an accountant?

In this respect, there is no difference between a Sole Trader and a Limited Company, there is no legal requirement to enlist the services of an accountant. You may, however, find it beneficial to have their advice and expertise on your side, to ensure you’re paying the correct amount of tax, and making full use of any tax benefits you may be entitled to. When it comes to completing your self-assessment tax return you may also find it much easier to hand over the responsibility to your accountant, so you can focus on your business, rather than getting bogged down with your finances.

Mistakes with the taxman can also become extremely costly, so it’s always advisable to enlist the services of a professional who knows what they’re doing and is able to get things right first time.

What records do Sole Traders need to keep?

You’ll need to keep records of the following:

• Your personal income
• All of your business expenses
• All of your sales and income
• If you’re VAT registered your VAT records
• If you employ anyone you’ll need to include your PAYE records

You’ll need these records in order to be able to calculate your profit and loss for your tax return.

How SG Accounting can help

Whether you’re just starting out and need advice on which business structure is best for you, are already set up and need ongoing accounting support or you’re currently a Sole Trader and need some help going Limited, our expert team of accountants are here to offer support and help. Get in touch with the team today, or take a look at our Sole Trader and Limited Company packages.