Every small business owner’s aim is to make a profit. When this profit arrives and the business grows, the complexity of the business can also grow and with this complexity operational and financial risk also increases. When this happens you may decide it’s time to change your trading status from a sole trader to a limited company.

Most businesses start as sole traders, especially if you’re working for yourself. This makes sense, at the beginning, because its super easy to start out this way but once employees, higher profits and business complexity start becoming part of your business reality, it can be beneficial to convert your business to a limited company.

But what’s the difference between a sole trader and a limited company? And what will change once you make the switch?

What is a Sole Trader?

As a sole trader, you are fully responsible for your business. This means you take on the financial and operational risk and so in theory your personal assets are at risk.

Tax

From a tax point of view you must pay taxes, through a Self-Assessment tax return each year, including Class 2 and Class 4 National Insurance and income tax. Sole traders don’t have to pay corporation tax this is reserved for limited companies.

Tax for sole traders, with relatively low profit, is generally lower than limited companies. But at a certain point it becomes more tax efficient to be taxed through a limited company. This is because as a sole trader you are taxed on all of the profits the business makes regardless of whether you spend them or not.

VAT

Sole traders are treated exactly the same for VAT as a limited company ,once your turnover reaches £85,000 must register for VAT. Provided your earnings stay below this threshold, you’ll find bookkeeping relatively simple as a sole trader.

Risk

Legally speaking, as a sole trader there is no differentiation between you, the individual, and your business. For small businesses, this usually doesn’t cause any issues, but as you grow and take on employees and more customers the business can become riskier.

It can be argued that operational risk is mostly covered by the businesses insurance so its really the financial risk that people worry about. The main question we get asked from sole traders is “is my house at risk if things go wrong” and the short answer is yes, probably.

If this type of risk is an unacceptable for you then it’s often advisable to switch your business to a limited company.

How a Limited Company Differs

A limited company is a trading status that is legally differentiated from the business owner. This means the company is its own person in law, under the guidance of it directors it can form contracts, take on financial liability, sue and be sued.

A limited company pays corporation tax on its profits, currently at 19%, and as long as you don’t take the money yourself, as owners, this is the rate the tax you pay.  This rate of tax is lower than that on which you would be taxed on as a sole trader.

If you do take money from the company, to pay yourself personally, you then pay additional tax but with a clever mix of salary and dividends it is possible to keep your tax lower than a sole trader.

So as well as paying less tax there is the security of knowing that your personal assets are protected if your business fails. Sadly, this isn’t the case as a sole trader–but switching to a limited company offers you this protection.

What else will change?

The company will need to have own bank account as opposed to a sole trader where you can use your personal bank account and the rules around keeping books and records are stricter.

You will become a Director of your company and as a director you have responsibilities and duties which are laid out in law and which can be punishable as a crime if not followed.

Our Advice

There is nothing wrong with trading as a sole trader. Paperwork is undoubtedly more straightforward, and you may enjoy having more control over your earnings and bookkeeping.

However, at a certain point, it’s advisable to move your business to a limited company. Not only will you find tax savings if your earnings are over a certain level, but you’ll enjoy the added protection of trading as a limited company.

So, if your business is taking off and getting more profitable then we advise checking with us to see if you would be better of switching from sole trader to limited company.