The ultimate back-to-basics guide: Sole Trader vs. Limited Company. What’s the difference?

Nov 2, 2022

Sole Trader vs. Limited Company

It’s a common question and one we hear often: sole trader vs. limited company quandary. What are the main differences? Here, in this jargon-free blog are all your answers.

You don’t need me to tell you how exciting and satisfying running your own business can be.

Pluses and Minuses

There are so many positives:

You’re your own boss, you can manage your own time, and to a degree, choose your clients. Finally, you get to excel doing something you love, so hopefully, it won’t feel too much like work. Being previously salaried did offer one key advantage, however – you paid your tax automatically through PAYE. Payroll did this for you. Tax management on your part was, well – minimal, or pretty low effort.

Being a business owner isn’t quite like that. Along with agency and self-determination, come your personal responsibilities to HMRC. And they are, of course, non-negotiable.

Things to Understand, Things to Know

Apart from generating sales within your business, there are also important matters to consider.

For example, understanding what a sole trader is, what being a limited company means, and which one is the most relevant status for you now, and into the future.

We’ve put together this guide with everything you need to know.

As you can imagine, not only is the following important to you as a business owner, you could find yourself down a rabbit hole if you’re trying to research this topic yourself. So, don’t sit and wonder. This piece is fairly high-level, so do get in touch and I’d be pleased to take you through how I can help you.

Let’s start with some definitions.

What is a Sole Trader?

A sole trader is a fairly simple business structure where you own and run your entire business. Most newly self-employed people start this way.

You may keep all the profits after taxes, and you’ll also need to pay Class 2 and Class 4 National Insurance. You must submit your tax return to HMRC on or before 31st January each year, recording turnover and business expenses for the previous tax year.

To give you the full picture, a sole trader is always self-employed, but not everyone who is self-employed is a sole trader. For instance, he or she may also run a partnership or be a director of a limited company.

Starting out? Unlike a limited company, registering as a sole trader is straightforward; the most common way is to register for Self-Assessment directly through HMRC’s website.

So far so obvious, but there could be a downside. And it’s this:

You are in effect your business – if that makes sense. What I mean is, should things not go so well, you will be personally liable for your company’s debts. All of them. You carry the can. Not to put too fine a point on it, you could lose a great deal in a worst-case scenario. And yes, this could include your property.

What is a Limited Company?

In a nutshell, as the name implies – and to cut straight to the chase – as the owner of the business, your liability is limited. The company you run has its own legal identity, and you would NOT be personally liable for any financial losses that may occur.

This section could also be called, reasons to hire a bookkeeper. Why? Because we can help you to operate as tax efficiently as possible, keep an eye on where your finances are, and, through removing the paperwork burden, help you to focus on running your business.

Limited company status is more structured; there are rules and regulations. Here are the “headlines”:

  • Filing your accounts is more convoluted. Let me explain.

Limited companies have to file a set of accounts, a Confirmation Statement (which is publicly available), and a Company Tax Return. Where sole traders pay tax on their profits, your business will be paying corporation tax, which if your annual income exceeds £50,000 will be rising to 25% from 19% from April 2023. As a director, you also have to file a personal tax return to HMRC.

  • Would you like to avoid a fine of £3,000 from the tax man? Answer: yes.

Then you must keep accurate and in-depth accounting records. These could include (but aren’t limited to) company assets, debts, stock, and goods bought and sold. Financial records need to be robust, too: details of all the money your company spends, all your invoices, plus bank statements and correspondence.

  • Equally, paying yourself is less flexible, and more involved. The most common way to do this is by combining a low salary and dividends, and withdrawing them from your limited company bank account.

Why and When to “Go Limited”

Given the value of property these days, most sole traders anticipate incorporation (as it’s known) when they buy a home. And, as you can imagine, the need for a bookkeeper and an accountant becomes abundantly obvious.

There are other benefits: having “ltd” at the end of your company name affords a degree of credibility and confidence. Should you make a loss, you can only use that loss against your own profits. Plus, you may attract investment more easily.

A Note on VAT

A misperception is that registering for VAT makes you a limited company. Actually, this is not the case – you can retain your sole trader status.

Here, I’m just reminding you that there’s a rolling turnover threshold of £85,000, over and above which you will need to get the VAT ball rolling. That is, 85K+ over any 12-month period, rather than a fixed period, such as a financial year.

A Note on Making Tax Digital

You may have heard of Making Tax Digital. This is an important development in the world of tax, and it will affect both sole traders and limited companies. And, it will be with us sooner than you realise.

If you are a sole trader, rather than filing your accounts just once on or before 31st January, there will be a seismic change. From April 2024, if your annual income is over £10,000, you will have to file your accounts every three months via HMRC-recognised accounting software, such as SAGE, or Quickbooks or Xero.

This is in addition to the submission of your annual accounts, which means that you’ll have to file five times a year.

(Limited companies will also need to comply by April 2026)

The plan is to make tax returns simpler and more efficient for everyone, and also for HM Govt to have a greater understanding and better control of our finances. As a sole trader, without a fully qualified cloud-based bookkeeper, “simpler and more efficient” may not be how you see it.

This could be hard work that you don’t need or deserve, so do get in touch. If you’re not MTD-ready, time has a way of running away with itself. Don’t be that person.

Whether you’re “limited” or not, outsourcing to a bookkeeper could be one of your best-ever decisions. The sole trader vs. limited company question isn’t too complicated. However, tax CAN be, and you need to get everything right.



Get In Touch

I can help with bookkeeping for start-up businesses If you’re in Worthing and surrounding areas and need help with your startup business, contact Angel Bookkeeping today on 07867 129210