When starting a business many people believe they need to set up as a limited company rather than being a sole trader.
We have already looked at starting a business in a previous blog and there is a lot to think about. One area is to consider how you will operate your business: as a limited company or sole trader.
You have to register yourself with the tax authorities when you are self-employed. If you try to operate without doing so, it could cost you in the long run as you could be fined or given penalties.
Many people think they have to be a limited company, but that means more red tape for you to deal with. When you are working alone you can choose to be a sole trader.
If you have a business partner, you could choose a partnership. Both these methods create a little less paperwork. So which should you choose? Should you be limited or a sole trader?
Sole trader
Self-employed people who solely own their business are known as sole traders. It is a very simple structure and is the most popular way to set up a business, with 3.5 million in the UK.
Being a sole trader means you are the business, whether you choose a trading name or not.
It is easy to do and you need to file a self-assessment tax return every year (before 31st January) so your tax and National Insurance Contributions can be calculated.
You are not required to give your details to Companies House if you are a sole trader.
As a sole trader you keep your profits, which you work out by deducting your costs, including allowable expenses, from your income.
There are some drawbacks when being a sole trader. Firstly, you have unlimited liability: that means if you have any outstanding loans or debts you are solely responsible for them. If things go wrong, you may need to sell your personal assets to cover debts or tax payments.
You may also find it is more difficult to borrow money or attract investors. If you earn in excess of £50,000, it may be more tax efficient to become a limited company, where you are classed as a director rather than the proprietor or owner.
Partnership
A partnership is similar to a sole trader but includes two or more people who own the business and they share responsibility.
Like sole traders, those in a partnership are the business and, therefore, draw earnings rather than receive a salary. This makes it more tax efficient for you. You also pay NICs in the same way as sole traders: you may pay Class 2 and Class 4 NICs depending on your income.
You don’t need to register at Companies House or file confirmation statements, something legally required by limited companies. It is best to draw up a partnership agreement, which explains the business structure, legalities and each partner’s responsibilities.
Like sole traders, you are liable for any debts of the business. If a partner is unable to pay their part of the debt, then the other partners are responsible for payment.
Limited companies
Choosing to be a limited company brings extra responsibilities compared to a sole trader, but there are advantages, too. Firstly, the company has a separate identity so you become a director of the business and earn a salary.
For tax purposes, many directors choose a low salary and are paid extra by dividends. The business itself will pay corporation tax, whereas your business pays income tax as a sole trader. Corporation tax attracts a lower rate than income tax.
Once registered at Companies House, which is a legal obligation, no one else can use your business name. That is not possible for sole traders.
You will have more paperwork to complete and additional responsibilities to report to HMRC and Companies House. It can mean you spend a lot more time on red tape and paperwork. Being a director is more than just a title, so check out what is involved legally on the government’s website.
As you are ‘limited’ should the business have financial problems and you have to close the business, your liabilities are limited. This means you are not liable for all the outstanding debts.
We have outlined pros and cons of the structure of businesses. For more detailed information you can find out more on the government’s website.
If you or your business is based in the South East of Wakefield District, you may be able to access free help from us as part of the PEAT Project.
If you are about to start your business, then it’s best to get advice before you make a decision. Making the wrong choice could cost you time and money later.
Email nparker@rcp21.com or kharrison@rcp21.com to find out more about the PEAT Project and what free assistance we have available for start-up, new and established businesses.
