Limited company or sole trader?

Should I set up a limited company or operate as a sole trader? This is one of the first questions that you will encounter when embarking on the journey of becoming an entrepreneur. This article will help you to decide.

 

Perceived benefits of limited companies

There are several benefits to incorporating (setting up a limited company):

  • Increases your chances of securing clients. Some clients are willing to deal with limited companies only.
  • Makes your business appear more professional
  • Limits your liability to the company and separate from personal assets.

However, some people are deterred by the prospect of additional administration of running a limited company. For this reason alone, they often choose not to incorporate but operate as a sole trader. The next question is – are they missing out?

 

Compare the tax bills

Let’s leave aside all the above qualitative factors, and compare the tax bills of the two operating models side by side.

Tax Sole Trader Limited Company
National insurance contribution 9% As low as 0%
Corporation tax N/A 19% – 25%
Tax free allowance on income £12,570 £12,570
Income tax rate 20%/40%
(on profit)
8.75%/33.75%
(on dividend)
Tax free allowance on dividends N/A £1,000

 

Recently, HMRC has increased the corporation tax rate. For company profit below £50,000, it is still taxed at 19%, but for profit above £50,000, it is tax at a gradually higher rate up to 25%. In addition, it also reduced the dividend allowance from £2,000 to £1,000 and increased dividend rate by 1.25 percentage point on basic rate, higher rate and addition rate. All these changes deminish the benefit of operating a limited company.

 

Who wins? – It depends!

In summary, after considering all the above factors, you can draw a dividing line – if your business makes less than £30,000 gross profit, operating as a sole trader will maximise your take home pay. If your business makes more than £30,000 gross profit, operating through a limited company will maximise your take home pay. Once your profit surpasses £90,000, it becomes more beneficial to operate as a sole trader again. If you are operating as a limited company and making profit towards it and want to avoid big changes, you can increase the employer pension contribution to reduce corporation tax. Here, gross profit = revenue – all costs excluding your salary. Both scenarios assume that you don’t have any other income. The table below illustrates the difference in take home pay at various profit levels.

 

Trading Profit Net income as
Limited Company
Net income as
Sole Trader
Net income differece
15,000 13,903 14,134 (231)
20,000 17,628 17,712 (84)
30,000 25,012 24,805 207
40,000 32,396 31,898 498
50,000 39,780 38,991 789
60,000 47,111 44,815 2,296
70,000 52,064 50,714 1,350
80,000 56,885 56,456 429
90,000 61,705 62,198 (493)
100,000 66,526 67,940 (1,414)

 

What if?

What if you have other income? such as employment income, property income. Well, the £30,000 line will apply to the total of your other income and the business gross profit.