The decision to become self-employed can offer a whole wealth of benefits but it can also feel like a drastic change. The freedoms that self-employment offer are counterbalanced by greater responsibilities as you become both business owner and employee. One such responsibility is the decision on what type of business that you want.
When it comes to business owners, there are two main types- those who are sole traders and those who trade as a limited company. Both types of companies share many similarities, particularly when it comes to day-to-day trading. However, there are some major differences that will dictate which type of business model is best for you.
What is a Limited Company?
Limited companies differ to sole traders in the amount of separation between owner and the business. Sole traders, as the name suggests are the sole owners of a business and both owner and company act as a single entity. However, limited companies are owned by shareholders, whether a single shareholder or many. Both the company and its shareholders are considered separate entities and therefore owners have a limited liability.
Liability is extremely important within business as it dictates the personal responsibility of a company owner. Sole traders face a higher risk when it comes to liability because their own personal assets are on the line, should the business fail. Whereas, limited companies offer some protection, particularly when it comes to personal assets such as savings, homes and possessions.
With such an obvious benefit, it may seem like registering your business as a limited company is the clear answer but there are also issues to consider.
Salary
Another major difference between sole traders and limited companies is payment. Sole traders will take their salary out of any profits that they earn. Limited companies have a slightly more complicated structure as there are multiple ways in which to take a salary. Directors can take a direct salary from the company, a dividend (which is tax free up to a specific boundary) or via director’s loans.
The process of taking money out of the company is obviously much more involved when it comes to limited companies, however, it tends to offer more options, particularly for businesses who earn larger amounts.
Tax
Another important distinction between the different types of self-employment is taxation. Again, sole traders have a much simpler process, as they complete self-assessment and the relevant taxes will be calculated and paid before a deadline. Owners of limited companies will also pay tax on any salary they take out of the business. They will also have to pay tax on any dividends they take. There is a tax-free allowance for dividends but this continually decreases and is therefore less beneficial.
Whereas sole traders will make national insurance contributions, limited companies will pay corporation tax.
Limited companies tend to allow for more tax efficiency as money can be reinvested back into the business. There is therefore more manoeuvrability for directors, as opposed to the straightforward approach for sole traders.
Admin
One of the main downsides of limited companies is the extra work that is required. For example, owners will have to register their business with Companies House, which comes with fees. You also have extra responsibilities, including annual company accounts and filing a company tax return each year. Many of these responsibilities come under the title of “Director’s Fiduciary Responsibilities” and will cost time, effort and may require the help of a trained accountant.
The upside of the extra responsibilities of running a limited company is that you are often seen as more official and bankable. For example, limited companies tend to have have more success when trying to get a loan from a bank, when compared with sole traders.
Registering your business as a limited company does offer many important benefits but it won’t be the ideal solution for everyone. Salhan Accountants have many years of experience in this area and can offer professional advice. Click here for more information
Incorporation – Accountants Birmingham and Droitwich (salhanaccountants.co.uk)
