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

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 20%
Tax free allowance on income £11,850 £11,850
Income tax rate 20%/40%
(on profit)
7.5%/32.5%
(on dividend)
Tax free allowance on dividends N/A £2,000

 

As you can see, operating as a sole trader you will firstly have to pay national insurance. This is based on the profit you make and kicks in at £6,205 (class 2) and £8,424 (class 4). On top of that you will have to pay income tax on profit beyond personal allowance. Operating as a limited company you will need to pay corporation tax on the company’s profit, and income tax on the salary and dividend you take out, but you can minimise national insurance contribution if you structure your salary correctly.

 

Who wins? – It depends!

In summary, after considering all the above factors, you can draw a dividing line – if your business makes less than £14,500 gross profit, operating as a sole trader will maximise your take home pay. If your business makes more than £14,500 gross profit, operating through a limited company will maximise your take home pay. 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.

 

Profit excl. salary Net income as
Limited Company
Net income as
Sole Trader
Net income difference
10,000 9,701 9,705 (4)
20,000 17,504 17,175 330
30,000 24,997 24,275 722
40,000 32,489 31,375 1,115
50,000 41,044 38,000 3,044
60,000 46,512 43,800 2,711
70,000 51,979 49,600 2,379
80,000 57,447 55,400 2,046

What if?

What if you have other income? such as employment income, property income. Well, the £14,500 line will apply to the total of your other income and the business gross profit.