Sole Trader or Limited Company

Many micro businesses start life as a sole trader. In the first year at least, if the profit is likely to be less than the owner’s personal tax allowance, this is the sensible thing to do. If you anticipate significantly higher earnings, or if your start-up really takes off, you should consider setting up a limited company to maximise your personal profit and reduce your personal risk.

What are the Risk Factors?

As a sole trader all the debts of your business are your own. If things go wrong, you risk losing any or all of your personal assets. If you own a limited company, the debts belong to the business, not yourself personally, unless you have signed any personal guarantees. You are not in danger of losing your home in the worst case scenario.

What are the Tax Factors?

As a sole trader all the profits of your business are your personal income and you are taxed on them accordingly. You will also need to pay Class 2 National Insurance (NI), currently set at £2.50 a week, and Class 4 NI on profits over the current threshold of £7,225.00.

If you set up a limited company, you could add members of your family or others as directors if you wish, or you could be a sole director. You do have to register as an employer and submit the relevant employee returns.

On profits of up to £300,000, the company pays corporation tax of 20%. It pays salaries to directors and dividends to shareholders. You will pay no tax or NI on a salary of £589.00 a month, which is an allowable expense against profit. If this is your only income and your personal tax allowance is the normal £7,475.00, as long as there is enough profit in the business, you could also pay yourself a dividend of up to £38,934.00 without incurring any income tax.

Get Professional Advice

On the face of it, as soon as a business becomes reasonably profitable, it would be wise to set up a limited company. Under some circumstances, it might even be wise to sell your sole trader business to the new company.

But things are rarely as simple as this. Most people have other income to factor into the equation, even if it’s just bank interest on their savings. You should always seek advice before setting up a private company. Discuss it with your outsourced bookkeepers, and if it still seems feasible, talk to your accountant. 

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