When starting a small business, one of the most important decisions is about choosing the right legal structure for your business. The different types can significantly impact key areas, including the payment of tax, control over the business, and legal liability.

The main options are:Man pointing at options
  • sole trader
  • limited company, or
  • partnership.

The UK private sector consists of six million businesses with sole traders being the most popular––there are about 3.5 million of them. Following those, 2 million businesses trade as limited companies and there are around 400,000 partnerships.

When it comes to choosing the best option for your business, there is no single magic answer. However, it is important to know the main differences, in order to understand what would be the best choice for you. In this blog post, we're going to focus on the two most common options - sole traders and limited––also known as "ltd"––companies

Let's take a look at some of the key questions we often get asked...

 

What is the difference between a sole trader and limited company?

 

Paying taxes as a sole trader

Being a sole trader is often seen as the simplest form of having a business, but in both scenarios, you are your own boss.

As a sole trader, you will need to do an annual self assessment tax return, where you pay income tax on what you earn from your self-employment. You're taxed on the profits that the business makes regardless of whether you take that money out or leave it in the business.

All your transaction data shown on your phone

Side note: Many sole traders use their personal bank account to start running their business. At untied, we don't require you to have a separate business bank account––we believe you should be free to run your life and your business as you want, although we know some banks prefer that you separate business from personal. untied's open banking technology links into most UK banks, regardless of what type of account you have.

Sign up for untied as a sole trader - free 30-day trial included

 

Paying taxes as a limited company

When you establish a limited company, your business is a separate legal entity, and you pay a different type of tax called Corporation Tax.

You also must keep annual statutory accounts, send an annual company tax return to HMRC and provide an annual confirmation statement to Companies House, which confirms the most recent information about your company.

You can do this yourself (untied is a good place to start!) or you can use an accountant. untied partners with accountants, so let us know if you need help finding one that works with limited companies.

Whether you choose to be a sole trader vs a limited company, you must register for VAT if the annual turnover exceeds £85,000.

Business finances will often be separate from your personal ones, usually kept in a separate business bank account.

 

National Insurance

National Insurance is a different type of tax from Income Tax, and represents the most significant difference between both legal structures.

As a sole trader, you only pay Class 2 and Class 4 NI contributions.

However, when you are a limited company owner, you will pay considerably more National Insurance, as you pay both the employer’s and employees’ National Insurance contributions.

 

Business Liability

As a sole trader, any business debts become your debts, as the business and you are treated together as one. That means, if the company got sued, you are personally liable.

As a director of a limited company you have limited liability if the business incurs any losses or debts, as those sit with the company. You're not completely and wholly responsible for the business, unlike when you're a sole trader.

Lady with arms in air doing her tax return

 

How do I pay myself from a limited company or as a sole trader?

If you have a limited company, you have to decide how you would like to pay yourself which can be through a salary by setting up a Pay As You Earn (PAYE) scheme or you can also choose to pay yourself through dividends.

Alternatively, you can opt to do a combination of both ways to pay yourself. There will be different tax consequences depending on which route you choose. 

As a sole trader, you don't receive a salary or wage in the traditional sense. Instead, you're paid based on 'drawings' from your business. You can simply ‘draw’ the money you have been paid by your clients from your account to pay yourself as a sole trader.

 

What are the advantages and disadvantages of being a sole trader?

Advantages

  • Registering as a sole trader with HMRC is free. If you're an untied user, we can do this for you
  • Little paperwork other than an annual self-assessment tax return
  • You don't need to set up a PAYE scheme to pay yourself
  • Greater privacy than a limited company, as company details are listed on the Companies House website
  • You keep all of your business’ profits as sole owner
  • Personal tax and national insurance is cheaper than for limited companies
  • You don't need to set up a separate business bank account
  • You can use the untied app (and even deduct the cost as a business expense)!

Disadvantages

  • You are fully liable for any loss your business makes, so you may have to use your own money to repay any debts, meaning that sole traders can lose personal assets if things go wrong
  • It is harder to get funding as a sole trader. Banks and other investors tend to prefer limited companies, which could limit expansion opportunities
  • There’s no one to share accountability with. Whilst you can hire staff, any and all important business decisions fall to you.

 Laptop users give high fives doing their tax return

What are the advantages and disadvantages of setting up a limited company?

Advantages

  • As director of a limited company, you can pay yourself in a combination of salary and dividends. With dividends having a lower tax threshold than salaried pay, this can mean you are much more tax-efficient than when just paying yourself a salary.
  • All shareholders have a limited liability should your business incur losses or debt; it’s not your personal responsibility. This means personal assets aren’t exposed – you only stand to lose what you put into the company
  • Should you ever wish to sell your business, there are likely to be more opportunities than with other business structures.
  • Once you’ve registered a company name nobody else can use it, in contrast to sole traders who aren’t offered the same protection (although a sole trader could register this as a trademark).

Disadvantages

  • There may be more difficult and time-consuming administrative and tax requirements running a limited company as opposed to operating as a sole trader
  • You need to set up a PAYE scheme with HMRC in order to pay yourself a salary
  • You’ll still need to do a personal self-assessment in addition to these other requirements
  • You’ll incur a tax charge on any assets bought through the company that are used personally – for example a company car charge
  • You’ll need a separate business bank account for the company
  • Information about your business can be found via Companies House, meaning details on directors and your company’s accounts are required to be shown publicly. This sort of transparency may not appeal to everyone.

 

Can you switch from being a sole trader to ltd company?

Yes, you definitely can! It is a fairly simple process. We see many people starting out as a sole trader and as their business grows, they then move to setting up a limited company. Some also move back to being a sole trader again.

 

Which is best for you?

Two people talking about the differences of sole traders and limited companiesThere is no right or wrong decision. Ultimately, you need to weigh up the difference between limited or sole trader, as the structure you choose could impact on everything from profits to paperwork. Don’t rush into any decision and speak to an accountant if you’re unsure, as their expertise is often invaluable when it comes to tax.

 

How to get started as a sole trader?

Just start trading!

Remember that you need to register with HMRC by 5 October after the tax year in which you start trading. As an untied user, we help you do that as part of our 5-star service so you can get your 10-digit Unique Taxpayer Reference (UTR) number, which you'll need to be able to file your taxes. 

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