One of the most popular questions we get asked by our start-up clients is “should I be a sole trader or set up a limited company?”. The answer to this question is not a simple one. There are so many individual things to consider that there is no standard textbook response. The biggest consideration is the inevitable tax bill, and which option is going to give you the lowest result. Here we will explain what you need to think about before making your decision, looking purely from a taxation perspective.
Types of tax and national insurance
To work out the most tax efficient solution for your business it is important to understand what types of tax you will be liable to pay under each setup.
Sole trader taxes
As a sole trader, you will be subject to income tax, class 2 and class 4 national insurance contributions.
Limited company taxes
A limited company is liable to corporation tax on its profits.
Limited company director taxes
As a limited company director, you will be taxed on the drawings you make from your company. There are three types of drawing a director can make from their company:
- Salary – salaries are declared through a payroll scheme and are subject to income tax and class 1 national insurance contributions.
- Dividends – dividends are liable to dividend tax, which comes at a lower rate than standard income tax. There is also a dividend tax-free allowance that can be used to reduce your bill further.
- Reimbursement of expenses – if you are reimbursing yourself for business expenses from the limited company then this is not classified as income and is therefore not subject to tax.
Which one is best for me?
The solution you select needs to be the one that is the most tax efficient for your individual circumstances. If you have other sources of income then these need to be considered too. You only have one set of allowances each year so you need to make sure that you are using them in the best way. If you are unsure then please seek professional advice and guidance.
Calculator
We have created a limited vs sole trader calculator to help you determine which option will give you the smallest tax bill if you have no other forms of income to consider. Simply change the figure in the yellow box to be your estimated level of profit and the calculator will work out how much better or worse off you would be as a limited company as opposed to a sole trader.
Download: Sole trader vs limited company 2018-19 Microsoft Excel
As you should be able to see, for most straightforward circumstances, any business making profits of £16,000 or more would be better off being a limited company from a taxation perspective.
Final considerations
Remember, the best setup for you and your business is not always the result that gives you the lowest tax bill. There are many other elements to consider (limited liability and industry being just two). If you would like specific advice on your individual circumstances then please get in touch for your free initial consultation by e-mailing us on [email protected]
