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Sole Trader vs. Limited Company — What's the difference?

November 24, 2021When starting your entrepreneurial journey, one of the first things you need to do is decide your business's legal structure. This might seem like a pretty straightforward decision to make, but choosing the right business structure can affect everything from how and when you pay your taxes to what happens if your company gets into trouble.However, depending on the nature of your business, you might find it beneficial to operate as a limited company from the very beginning. In this article, we dive into what the difference between a sole trader and a limited company is, the benefits and drawbacks associated with each business structure, and how you can choose the right business structure for you.

What is a sole trader?

Benefits of being a sole trader

Simple set up

Privacy

Sole traders also get a lot more privacy than their limited company counterparts. While sole traders only have to notify HMRC that they are trading, limited companies must register with Companies House, and once registered will have their company's information readily available to view on their website.

Drawbacks of being a sole trader

Unlimited liability

While you are in complete control of your company as a sole trader, in the eyes of HMRC you and your business are a singular entity, meaning that you are personally responsible if anything goes wrong. As a result, if your company falls into financial trouble, your personal finances and personal assets can be used to pay off outstanding debts.

Can be less tax efficient

While operating as a sole trader when starting out can be more cost-effective in the short-term, sole traders can expect to see the amount of tax they pay rise substantially as their income increases. Alongside a weekly flat rate set by the government for paying Class 2 National Insurance, sole traders must also pay Class 4 National Insurance and Income Tax, with the amount determined by their taxable profit. This means that sole traders with a taxable income above £50,271 will fall into the higher rate Income Tax band, with a tax rate of 40%.

What is a limited company?

Benefits of being a limited company

Limited liability

As mentioned above, while sole traders are seen as a singular entity with their business, limited companies are seen as a separate legal entity altogether, meaning that if the business gets into trouble the owners' personal finances are not at stake. Since the company is owned by shareholders, the owners only stand to lose what they invest in the company.

More tax efficient

Name claim

Drawbacks of being a limited company

Publicly available information

One aspect of operating as a limited company that many business owners find unsettling is the amount of information that is readily available to the public. Once the company has registered with Companies House, the information about that company remains on the website indefinitely, including the company's registered address and the full names of the company directors.

Limited autonomy

For companies that choose to have more than one shareholder, the director of a limited company may find that the influence they have over their business is restricted. While sole traders are entirely free to determine the direction their business takes, limited company founders must compromise with the interests of their shareholders, ultimately capping the control they have in decision making processes.

A lot of paperwork (unless you're with Ember)

Unlike sole traders who only have a Self Assessment tax return to worry about, limited companies deal with a lot of paperwork. Once registered with Companies House, the limited company must prepare and file statutory accounts in the format prescribed by the Companies Act, and must subsequently complete a Confirmation Statement each year informing Companies House of any updates or significant changes that have happened in the last year. Limited companies must also file Corporate Tax returns and annual accounts on a yearly basis, with supporting calculations needing to be provided.As a result of the above, limited company owners may find themselves stretched thin between running a business and keeping on top of their business admin. This would previously have meant that limited companies would have had to splash out on an accountant and an accounting software, but with Ember on hand to automate their accounting, limited company owners can cross this off of their list of things to worry about.

Sole trader vs limited company

If you're still not sure whether you should operate as a sole trader or a limited company, we've come up with a few questions to ask yourself to help you come to a decision.

Does having company information publicly available worry you? If you'd rather keep your business details private, you might prefer to operate as a sole trader.How important is it to you to limit your exposure if a claim is made against the business? Limited company shareholders only stand to lose what they invest in the company, whereas sole traders risk losing their assets if they cannot afford to settle claims or pay outstanding debts.Do you expect to make a loss in the early years of trading? Sole traders can claim back on tax to offset any losses made.How much do you expect to make in profits? If you're expecting a profit of over £50,271, you might find it more tax efficient to operate as a limited company. Sole traders must pay tax on their business profits (minus expenses) and can be taxed up to 45%, whereas limited companies paying Corporation Tax are only taxed 19% on company profits.