Sole proprietorship means that you run your business as an individual and are effectively self-employed. This is the most common trading method in the UK. 3.1 million sole proprietorships recorded at the beginning of 2022.
In contrast, a limited liability company is a separate legal entity with separate finances.
Each option has its own pros and cons, and anyone starting a business must decide which method is best for them.
Here we’ll look at some of the key differences regarding legal liability, taxes, and bureaucracy.
See: Should I transition to a sole proprietorship, partnership, or limited company?
responsibility
The main advantage of a limited company structure is that it locks in personal property. If your business fails or is sued, you only lose your investment in the business and you are personally liable for costs such as legal fees and damages from your own finances. No. However, in some cases, the lender may require a personal guarantee.
As a sole proprietor, you and your business are one legal entity. You are personally responsible for the liabilities you incur in running your business, including taxes, and are exposed to greater financial risk if something goes wrong.
However, a sole trader structure can offer some economic benefits.
Losses incurred as a sole trader can be set off against other income for tax purposes. This cannot be done in a limited company structure as the company is a separate legal entity. For many business start-ups that may incur initial losses by the time the business is established and finds a foothold, operating as a sole proprietorship can offset losses against other income and reduce taxes. There is an advantage.
Also, because your finances and business finances are legally one and the same, you are free to borrow from business funds to cover personal expenses as needed. However, it is important to remember that the profits you draw from your business will still be taxed.
tax difference
limited company tax
A limited company must pay corporate tax.
As of April 6, 2023, it is 25%, up from 19% previously. This applies to companies with profits of £250,000 or more and applies to all profits. A small profit margin applies to companies with profits of £50,000 or less. Companies with profits between these thresholds are provided with a system of taper relief. Find out how much to pay using government calculators.
When extracting value from your business, you may pay additional taxes based on your salary (which can be deducted from company profits) or taxes on dividends (paid) that you decide to pay yourself, such as income tax or National Insurance Contribution (NIC). Taxes may occur. of after-tax profit). However, you can control when and how the extraction is done.
sole proprietorship tax
Tax laws are different for sole proprietorships. You pay income tax on your business profits, regardless of whether you extracted the profits for your personal use or invested them in your business.
In addition to paying income tax on business profits, self-employed sole proprietors must also pay a Class 2 NIC (£3.45 per week in tax year 2023/24 if they exceed the lower profit threshold of £12,570 per year). lb). and Class 4 NICs (9% of business profits between £12,570 and £50,270 and 2% of profits above £50,270 in the 2023/24 tax year). If his taxable turnover exceeds his VAT registration threshold (£85,000 in 2023/24), he must also be registered for VAT. This is all calculated and reported to HMRC through the annual self-assessment process and completion of self-assessment tax returns.
See: 5 Common Tax Mistakes If You’re Self-Employed
Main difference
Due to their lower corporate tax rates, limited liability companies generally tend to be more tax efficient than sole proprietorships, as profits are taxed less, especially for companies with lower turnover. This is especially true when profits are invested in the business rather than extracted. This is because profits invested in a business are taxed at a lower rate than if the business were operated as a sole proprietorship.
A limited company can also offer a wide range of tax-exempt benefits to its directors and employees, opening up access to certain tax exemptions that are not available to sole proprietors, such as the R&D tax credit.
However, unlike sole proprietorships, you cannot borrow money from your company’s bank account for personal use. Doing so in a limited company is considered a “benefit in kind” and has potential tax implications.
Officials
A limited liability company structure offers limited liability and potential tax benefits, but requires more bureaucracy to set up and administer.
Overall, the limited company structure comes with more reporting requirements, and in return for the benefits of limited liability, company directors Broad range of duties and fiduciary responsibilitieswhich can result in additional costs and paperwork.
For example, directors of a limited company must register their business with HMRC and are required by law to set up a bank account in another company. An account must be created and submitted to her HMRC each year. You may also need an audit. This reduces your privacy as these accounts, along with your details and those of other directors, are available online to anyone via the company’s home.
However, the limited company structure offers great flexibility in how shares are allocated and people are hired, issuing company shares to spouses and family members, or appointing payroll directors to improve tax efficiency. You can A corporate structure also helps you appear more professional to your clients and suppliers.
Setting up a sole proprietorship is the easiest way to get your new business off the ground, as setting up a company requires additional formalities.
To become a sole proprietor, you must be registered with HMRC as a self-employed person. It consists of a simple online registration form. However, timing is important as financial penalties can occur if you fail to register after you have started trading but before the end of the relevant tax year.
Unlike a limited company structure, as a sole proprietor you are not legally required to open a separate business bank account. That said, it’s generally recommended to do so to better track your business income and expenses and help you prepare your tax returns.
Profits for sole proprietorships must be calculated for each tax year (6 April to 5 April). Like a limited company, accounts (i.e. records of business income and expenses) must be prepared in order to determine the profit of the business, but unlike a limited company, an audit or HMRC is required unless specifically requested. No need to submit to
It is possible to change from a sole proprietorship to a limited company and vice versa, but it is usually easier to start as a sole proprietorship and later incorporate rather than vice versa.
Ultimately, it’s important to think carefully about what’s best for you and seek professional advice if you’re unsure. Having the right structure in place for your particular situation and ambitions will lay a strong foundation for future success.
Haydn Rogan is a tax expert and partner in a national law firm. waitmans.
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