Sole Trader versus Limited Company
by Lindsay Roadnight
last updated: 28/02/2022
One of the most common questions that comes up when people are setting up their private practice is whether to work as a sole trader or register as a limited company. If you’ve only ever worked as an employee or a volunteer, this may be your first foray into the world of self employment and you might be feeling a bit overwhelmed. Let me help.
What is a Sole Trader?
A sole trader is the legal name for a self employed person. To set up as a sole trader, you need to register with HMRC so that you can pay your income tax through self assessment. If you already complete a self assessment, you still need to register your sole trader business. As a sole trader you get to keep all the profits from the business (after tax) but you are also personally liable for any losses incurred by the business.
What is a Limited Company?
A limited company is a legal entity in its own right. The owners of the company can withdraw the profits (after tax), but it is the company that is liable for any losses, not the owners. This is where the term ‘limited’ comes from – the company limits your personal liability. As a company owner (‘director’) you can be employed by the company, so you are not technically ‘self employed’.
What's best for me?
There are various advantages and disadvantages to either corporate structure and which one is best for you will depend on your personal circumstances. A lot of the decisions are influenced by your tax arrangements which can be complex. I would always recommend seeking out advice from a Chartered Accountant, who can review your individual circumstances and advise accordingly.
Whichever structure you choose, it will have an impact on how you run your business, what records you need to keep and how you interact with HMRC.
Sole Trader - Overview
Setting up as a Sole Trader is quick and easy. For the vast majority of Private Practitioners, this will be the easiest and most efficient way of running their business. Simply register with HMRC (www.gov.uk/register-for-self-assessment/self-employed) and complete your Self Assessment each year.
You need to keep records of your income and expenditure for the business and you need both these figures for your Self Assessment. Simply enter your income and the allowable expenses and your tax will be calculated against your Profits (Income minus Allowable Expenditure). For more information on Allowable Expenses for Sole Traders, go here.
Should your Sole Trader business fail, you will be personally liable for any debts owed by the business. Debtors will be able to recover their outstanding debts from you.
Limited Company - Overview
Running a Private Practice through a limited company is slightly more involved. You need to register your company with Companies House. The name for your company has to be unique. Each year you need to complete the Company Return and Accounts for the company and register these with Companies House. I would highly recommend using an accountant if you opt to set up a limited company.
You still need to register with HMRC for Self Assessment as a director of your own company. Each year you will need to complete a Self Assessment to declare how much income you have taken from the limited company.
The Limited Company is it’s own legal entity. It is separate from you. This gives you a form of financial protection should the business fail. Any monies owed by the company can only be recovered against company assets. Your personal assets are protected.
Other benefits of running a limited company are:
- You can claim Personal Therapy through your business if you run as a limited company.
- Paying into a private pension from a limited company is very tax efficient.
- You can limit your income tax liability as you only pay income tax on money withdrawn from the company.
Whether or not these benefits are beneficial to you will depend on your individual circumstances.
Examples Of Differences Between Sole Trader and Limited Company
Renting An Office
Renting a room is a large financial commitment. If you rent a space for £300 per month for 3 years, that’s a total of £10,800. As a sole trader, it would be your name on the lease and should your business fail, the landlord could recover the remaining outstanding money on the lease from you personally. If you are running as a limited company, it would be the company’s name on the lease and the landlord would have to recover the outstanding money from the company assets. Your personal finances would be unaffected.
Controlling Your Income Tax
When you run as a limited company, you are only taxed on the income that you draw down from the company. This means you can control the amount of income tax you pay and when you pay it. A simple way to look at this, would be to consider if you had profits of £36K in a year. A sole trader would be taxed on the £36K, however as a director of your company you could choose to draw down only £12K and leave the remaining £24K in your company, which would mean your income would be under the tax threshold and you wouldn’t be liable for any income tax.
This is quite a simplistic view, and there are other considerations such as NI contributions and Corporation Tax to consider.
Mythbusting
The question of whether it’s better to be a sole trader or a limited company is very common when starting out in your private practice. Check out my latest blog talking through some of these myths here.