Self employment isn’t as simple as finding clients and starting to work. Before you can start working for yourself you need to carefully weigh the pros and cons of the legal form your business is going to take. There are two ways in which you can work as a self-employed person, and there are benefits and drawbacks to both.
What is the difference between a limited company and a sole trader?
Sole trader
Setting yourself up as a sole trader is probably the easiest and most popular option for those who are just starting out. People that consider themselves ‘freelancers’ or self employed are sole traders. You need to register with HMRC as a sole trader, which means that you are then considered to be in business for income tax purposes. You should register as soon as you begin trading but you must register by 5th October in your business’s second year of trading at the very least, so that you can begin paying tax.
You are required to keep all of your accounts up to date, as well as evidence of invoices and payments, and then fill out and submit a self assessment tax return by January of the following year in order to pay your tax. Sole traders are also required to pay class 2 and 4 National Insurance Contributions (NICs), which are worked out automatically when a tax return is filed online.
Limited company
Limited companies are more complicated and require more upfront work to get set up, but if you are an individual you are still able to set up as a limited company if you want to. Limited companies feature directors and shareholders, and if you set up a company as an individual then you will become both the director and the only shareholder, but your company has the opportunity to grow from here. As a limited company you will take your wages in the form of a salary, or from dividends, or more usually, a mixture of both.
You need to register with Companies House as a limited company, and give personal details such as your name, address and date of birth which will be listed on the Companies House roster publicly. You need to provide all of your annual accounts and a confirmation statement each year, which are also published publicly.
Benefits of being a sole trader
Quick and easy
The process of setting up a limited company is far more involved than becoming a sole trader. Although you do need to register with HMRC you can pretty much get started right away after this. A limited company requires a little more time, knowledge and business acumen, which can be overwhelming for those just starting out. Don’t forget that you can always become a sole trader first, and then form a limited company later, as well, so you aren’t tied to the choice you make if you go down this route.
Privacy
You don’t have to publish all of your details with Companies House if you start out as a sole trader. Most new businesses will fail in the first 18 months, and for those who value their privacy and the ability to project their own business image this puts a lot of pressure on them. As a sole trader you aren’t required to post your own details, or details of your accounts, online.
Control
Although you can work alone as a limited company, it is usual that you will bring on further directors and shareholders over time. This means that control over your business may have to be split over time, a fact which is frustrating for many business people. If your business is your baby, the last thing you want to do is allow other people to make decisions you don’t agree with. It is also easier to make decisions if you are working alone.
Allows for closer connection with clients
If you are a smaller business with close ties in the local community, you may find that people feel a stronger connection with an individual than they do with the faceless company. As mentioned above, you are also able to make decisions on your own, meaning that you can make them quickly and provide a more bespoke experience for your customers.
Benefits of being a limited company
Pay less tax
You may be able to pay less tax as a limited company. As of this year, corporation tax stands at 19% and is set to go down to 17% by 2020, making for a competitive rate. On top of this, if you are taking your wages home in the form of company dividends, you will not be subject to NICs and will be able to take home more of your profit than if you were a sole trader.
Business and personal lives are separate
If your business is set up as a limited company your finances within the business are considered separate from your personal finances. This means that if the worst happens and your business does run into financial trouble, you won’t be expected to bail the business out using your own money. Sole traders do not have this protection, so if they run into trouble and owe money to customers or lenders they will be forced to bail themselves out with their own money, which could lead to bankruptcy in the worst cases.
Trust and authenticity
A limited company has a ring of authenticity that sole traders don’t have. If you are looking to take your business to a wider audience, there is a better chance of them taking you seriously if you are a limited, registered company. A limited company offers a feeling of permanence that resonates with customers, so they are more willing to invest their money in you. The fact that you need to be more on top of your finances and understand business better helps customers to trust that you know what you are doing and will provide a professional service.
Further information and help
Sometimes the choice of whether to set up as a company or sole trader is easy, for the times when it is not an Accounting Gem advisor can talk you through all the pros and cons of both approached. Making the right decision at the outset will have a material impact on both the success of the business and the amount of money you can withdraw from it – so it’s a decision it is important to get correct
Please call us on 01473 744 700 or email us on contactus@aag-accountants.co.uk to find out more and discuss further.
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