One of the most common questions we are asked by new and growing businesses is:

"Should I stay self-employed, or should I set up a limited company?"

There is no single answer that suits everyone. The right structure depends on a number of factors, including your level of profits, future plans, appetite for administration effort and how much personal financial protection you require. In many cases, the right answer changes as your business grows.

Below is an overview of the main differences.

Sole Trader

A sole trader is the simplest way to run a business. There is no legal distinction between you and your business, meaning you are personally responsible for all business debts and obligations.

Advantages

• Simple and inexpensive to set up
• Less administration than a limited company
• Business profits belong to you personally
• Easier bookkeeping and reporting requirements
• Greater privacy, as your business accounts are not publicly available

Things to consider

• You are personally liable for business debts
• It can be more difficult to raise finance or attract investors
• As profits increase, the overall tax burden may become higher than operating through a limited company

Limited Company

A limited company is a separate legal entity from its owners. The company owns the business assets, enters into contracts and is responsible for its own debts.

The owners (shareholders) generally have limited liability, meaning their personal assets are usually protected if the business experiences financial difficulties.

Advantages

• Limited liability offers greater protection for your personal assets
• Often viewed as more established and professional by customers, suppliers and lenders
• May provide greater tax planning opportunities as profits increase
• Can make it easier to bring in business partners or investors

Things to consider

• More administration and statutory reporting requirements
• Annual accounts and a Confirmation Statement must be filed with Companies House
• Corporation Tax returns must be submitted to HMRC
• Directors have legal responsibilities under company law
• Accounting and compliance costs are often higher than for sole traders
• Company accounts and certain information are available on the public Companies House register

How are they taxed?

Sole traders

Sole traders pay Income Tax and National Insurance on the profits of their business through their annual Self Assessment tax return. Business profits are treated as the owner's personal income, regardless of how much money is actually withdrawn from the business.

Personal Allowance is available to set against business income, reducing income tax liability.

Under certain circumstances, trading loss relief can be used to offset loss against general income and capital gains, thereby reducing overall tax burden.

Limited companies

Limited companies pay Corporation Tax on their taxable profits.

Company owners are taxed separately on any salary, dividends or other income they receive from the company.

This can provide greater flexibility in how income is extracted and in timing of those payments, although the most tax-efficient approach depends on your individual circumstances and current tax legislation.

Which option is right for you?

A sole trader may be suitable if you:

• are starting a small business
• expect relatively modest profits
• want a simple and low-cost business structure
• have limited administrative resources.

A limited company may be more appropriate if you:

• expect your business profits to grow
• wish to reinvest profits into the business
• want the protection of limited liability
• are planning to employ staff or bring in business partners
• wish to enhance the professional image of your business.

It's about more than tax

Many people assume that forming a limited company is always the most tax-efficient option. In reality, tax is only one factor. The decision should also take account of:

• administrative responsibilities
• legal obligations
• business risks
• future growth plans
• financing requirements
• succession and exit planning.

Choosing the right structure at the outset can save both time and money as your business develops.

What it means for you

There is no "one-size-fits-all" answer. What works well for one business owner may not be the best solution for another. Many new businesses begin as sole traders because the structure is straightforward and inexpensive. As the business grows, it is often worth reviewing whether operating through a limited company has become more advantageous.

If you're thinking about starting a business, or wondering whether it's time to incorporate your existing business, we'd be happy to discuss your circumstances. We can explain the tax and practical implications of each option and help you choose the structure that best supports your business goals.