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Sole Traders Vs Limited Companies: What’s The Difference?

There are a number of differences between sole traders and limited companies, from taxes to financial security. But have you ever wondered whether you should change from your current legal structure to the other?

This post aims to highlight some of the differences between them so that you can decide what’s best for your business in the long run.

What is a sole trader?

A sole trader business is owned and controlled by a single, self-employed individual. There is no legal difference between the business and the individual running it.

This can be seen as a huge disadvantage of this set-up because the individual has unlimited personal liability for all business debts and losses.

As a result of this, you can lose your house and all of your savings if you are unable to pay any debts incurred by the business. If you’re unable to pay them at all, it can result in personal bankruptcy.

What is a limited company?

A limited company is owned by one or more shareholders and is managed by one or more directors. An individual can be both a shareholder and a director of the same company, this means that they both own and control the business.

Limited companies have their own legal identities and are liable for their own debts, losses, and legal claims brought against them. This means that the company owners have some level of protection for their own finances.

This limited liability can be reason enough that many small business owners choose to set up a limited company. However, this isn’t the only benefit that company owners can enjoy. 

Company ownership

  • The company can be owned by more than one person, which can be a bonus when it comes to decision-making and smooth running. This is different from a sole trader setup, where there is only one business owner and they are responsible for everything the business does.
  • In a limited company, if the director was to pass away, the company would still exist in its own right. This is known as “perpetual succession”. However, if a sole trader passes away, their business ceases to exist.
  • You may find that you have a greater number of clients you can work with when you’re a limited company. This is because some industries prefer the protection of limited liability and may refuse to work with sole traders.

Income and taxation

  • Directors are paid through PAYE, which means they pay Income Tax and Class 1 National Insurance on any amount above their Personal Allowance.
    As well as this, they are able to take dividends that are taxed between 7.5% and 38.1% (for more information on dividend tax, please check out our previous blog post: What Is Dividend Tax?).
    Both of these are lower than the Income Tax (20-45%) and National Insurance Class 2 and Class 4 that sole traders have to pay on their income through Self Assessment.
  • A limited company has its own credit profile and can borrow money in its own name. Therefore the company is liable for any debt that is taken out against it. This is different from sole traders who have to borrow against their own credit rating and take out personal loans to fund the business.

Expenses and benefits

  • Company directors may be able to claim Statutory Sick Pay (SSP), however, sole traders are not eligible to claim this.
  • Through the company, there can be access to more favourable pension scheme options. However sole traders can only use a personal pension scheme.

If this post has persuaded you to become a limited company, then keep your eyes peeled for our next blog post which will walk you through the process of changing from a sole trader to a limited company.

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