When starting up your business, first thing you will have to do will be to decide whether to set up a new limited company or become self-employed. If you choose to go self-employed, this could be either as a sole trader, or as a partner in a partnership.
The two different business structures have their own advantages and disadvantages, so it is vital you understand what each of them offers you. Working out which option best suits you, and your new business, can take a little time but it is an important decision, so you do want to choose the business structure that best suits your circumstances.
There are some differences between working as self-employed and setting up a limited company.
How are sole traders and limited companies taxed?
If you are self-employed, your business profits and other personal income is taxed via the annual self-assessment.
The personal allowance for 2018/19 tax year is £11,850 – you pay no income tax on this amount. Depending on your annual profits, you pay income tax at 20% (0-£34,500), 40% (£34,501-£150,000), or 45% (over £150,000).
In addition, you must pay National Insurance Contributions (NICs) on your profits. Class 2 NICs are £2.95 per week (2018/19 tax year), and HMRC will calculate your Class 4 NICs on your annual profits, 9% (£8,424-£46,350) and 2% (excess over £46,350).
Limited companies are liable for Corporation Tax on their business profits. The Corporation tax rate is currently 19% (2018/19 tax year).
What are the benefits of incorporating vs becoming a sole trader?
- One of the main benefits of working via a limited company is that your personal and business finances are distinct, so if a claim is made against your company, you will not be liable personally.
- Under the sole trader, if a financial claim is made against your business, your own personal finances may also be included in any settlement.
- Setting up as a sole trader is a very simple process. All you need to do is to inform HMRC of your intention to go self-employed, you can start trading right away. You can do it online, by phone or ask your accountant for help.
- Limited company directors have to deal with more paperwork and have various legal and statutory obligations. Limited companies are regulated by Companies House and directors are ultimately responsible for providing accurate and timely accounts on an annual basis.
- Limited company directors stand to be more tax efficient that sole traders, as rather than paying Income Tax, they pay Corporation Tax on their profits. In addition to this, there is a wider range of allowances and tax-deductible costs that a limited company can claim against its profits.
- Once you have registered a company name nobody else can use it, in contrast to sole traders who are not offered the same protection.
There is no better or worse business structure, just the one that suits your individual situation. Once you understand the main benefits of each option, you can make an informed decision. If you start out as a sole trader, and later wish to form a limited company, it is possible to do so.
The route you choose is up to you. Do not rush into any decision and speak to an accountant if you are unsure, as their expertise can be invaluable when it comes to the tax facts.