The key distinctions between sole traders and limited liability businesses
A sole trader is a self-employed person who owns their business entirely and does not have a legal identity separate from the owner. As a result, a solo trader assumes entire responsibility. You must register as a sole trader with the government portal within three months of starting your firm.
A limited liability company is one that is legally separate from its owner's personal identity. It has a distinct corporate identity that must be registered with Companies House (for a modest price). As a result, there may be multiple owners or directors, each with limited liability – meaning their personal fortunes will be unaffected if the company fails financially.
Which is better for your business: a sole trader or a limited company?
Being a sole trader has a few financial benefits for many small firms or self-employed tradespeople, but it also comes with a higher amount of risk. Being a limited company helps protect owners from these dangers by limiting their responsibility, but it also means that the directors will have a lot more administrative and fiduciary responsibilities.
We'll go over the advantages and disadvantages of several features of both models, such as earning potential, tax efficiency, and obligation, in this part.
Earnings
After tax, which is paid through the self-assessment system, sole merchants keep all of their earnings. This implies that your earnings are entirely dependent on your performance that year - so while you could make a lot of money, there's also a chance you won't make enough to make a reasonable living.
A limited company's earnings are paid out in the form of a salary, which is taxed at the regular PAYE rates. Subject to overall success, they can also get bonuses and dividends from their earnings. The tax-free dividend allowance has been reduced by the government in recent years (from £5,000 in 2017 to £2,000 in 2021), resulting in a drop in tax-free profits from these new sources of income for limited company directors.
Tax
Limited companies must pay corporation tax because they are registered with Companies House. Corporation tax rates are actually lower for large corporations than they are for single traders, making it a significantly more tax-efficient form for enterprises with huge turnovers and profits.
Sole traders, unlike limited corporations, are not required to pay corporation tax. Instead, sole traders must pay regular income tax and make National Insurance contributions on all earnings, which are calculated at a Class 2 rate if profits are £6,515 or more (for the tax year 2021/22), and a Class 4 rate if profits are over £9,568 (for the tax year 2021/22). Any business expenses are tax-deductible, so you'll just pay taxes on your profits. More information can be found at National Insurance Contributions Guidance (.gov.uk)