Which is better: limited company or sole trader?

Mar 17, 2022

If you’re just starting your own business, the chances are you’re considering operating as a sole trader – it’s practically the default option for new business owners.

But what about setting up a limited company? Could you run one of those yourself?

Broadly speaking, yes, you could.

But before you decide, you need to know the difference between a limited company and sole trader so you can choose which business structure is best for you.

Differences between a sole trader and limited company

As you might have been able to gather from the name, a sole trader is an individual who is solely responsible for the business.

Legally speaking, if you’re a sole trader, there’s no difference between you and your business.

In other words, what you earn, the business earns. What you own, the business owns. And what you owe, the business owes.

That’s not the case for the owner of a limited company, who is ordinarily not liable for the debts of the business.

That’s because, legally speaking, the company and director, even if they are the majority shareholder, are two separate entities.

Sole trader positives and negatives

Being a sole trader is relatively straightforward as there is less administration to worry about.

There is less paperwork, fewer registrations to make and you only usually have to file a single tax return a year – your self-assessment tax return.

However, sole traders that earn a lot of money sometimes end up coughing up more in tax than the owner of a limited company .

This is because the profits of a sole trader business are liable for income tax, and the highest income tax rate is 45%.

Company profits, meanwhile, are liable for corporation tax, which is 19% for the 2022/23 tax year.

Furthermore, we cannot overstate how important it is for sole traders to remember that their assets, including their home, might be on the line if their business cannot pay its creditors.

Furthermore, if your business does go bust, you could face personal bankruptcy and all the restrictions that brings.

Limited company positives and negatives

If you run a limited company, you ordinarily shouldn’t face such threats to your personal assets if things go wrong – again, you and your company will be completely separate legal entities.

As we mentioned, company profits can be taxed at a more lenient rate than the profits of sole traders.

However, you would be right for wondering how exactly you would personally get paid.

Here too, directors can benefit from tax savings as they have the opportunity to top-up their salary with dividends, which are also taxed at lower rates than regular income.

The main disadvantage of limited companies is the extra responsibilities you’ll have.

These include, but are not limited to, registering with Companies House, where you will need to send formal annual accounts, submitting corporation tax returns and maintaining statutory records.

Which business structure should I choose?

Even after taking all that on board, it’s tough to know exactly which business structure is right for you. So, what’s our advice?

Broadly speaking, it all depends on your circumstances and the risks involved in your business.

You should always talk to your accountant before you incorporate your business, as it is a complex task and you need to make sure it’s the right choice for you.

Talk to us about your business structure.