Important decisions come with starting a business, including whether to go self-employed or set up as a limited company. Every business, irrespective of the size, must have a legal structure.
Here we will be discussing the processes and legislations to becoming a limited company or a self-employed contractor. Either structure will bring its own benefits and drawbacks. The choice you make is vital as it affects your business, including legal and tax responsibilities.
If you are unsure whether to operate as self-employed or as a limited company then contact CloudCo for accounting advice.
Limited company vs being self-employed
Operating through a limited company has many benefits, but as always, depends on your circumstances, your business objectives, and financial targets.
Equally, the sole trader structure may offer greater freedom in terms of personal liability to others in your company, but with this freedom also comes setbacks.
Let’s look briefly at the benefits of each business model to understand which may be better for you.
Limited company
- Separate legal entity. Even as a shareholder of a limited company, your personal assets are not at risk in the event of solvency or, in other words, if your company is going bankrupt.
- Tax Purposes. Yes, a limited company is typically better in terms of the taxes you pay, but tax planning is vital. Also, the company’s administration must be done on time and in full compliance.
- Shareholders and company director. If you’re looking to expand the business in the future and bring in more directors to share the responsibilities, then limited companies certainly provide this scope.
- Credibility. A limited company structure does provide a certain credibility thanks to having a company director and various creditors and shareholders putting stock into the company.
Self-employed
- Sole trader flexibility. Sole traders in the UK can keep their affairs simple and their overall feeds lower in the early days their own business. If things do not work out, unlike a limited company director, you can wrap things up and move on much more easily.
- Privacy. Your name and details are not in the public domain unlike with limited companies.
- Cost effective. You’ll notice more personal income, providing you correctly balance your tax and national insurance payments. Business admin wise, your major responsibility will be to complete and file a self-assessment return by 31 January each year. However, this is not always easier. Hence, utilising the services of an accountant, such as ourselves, can be beneficial.
- Tax neutral. If your profits are in the region of £20,000 or lower, then the difference between a sole trader and a limited company with regards to taxation is minimal.
Corporation tax
Corporation tax rates for a limited company require you to pay 19% corporation tax (at the ‘small profits rate’ if your company made a profit of £50,000 or less; or main rate at 25% if your company made more than £250,000 profit), on your profits and company directors pay their own income tax on the salary they draw from the company. This is not a concern for those operating within self-employment.
Companies house
Limited companies need to register through Companies House. This is not a concern for self-employed people.
Personal assets
Sole traders risk losing their personal assets if their new business sinks, and they owe monies to various entities, especially HMRC.
What is the difference between Ltd and self-employed?
Comparison between a limited company vs self-employed:
Limited Company | Self-employed |
| A limited company is a type of business structure that has its own legal entity, separate from its owners. | Self-employed individuals earn income by contracting with a trade or business directly. It is the simplest form of business structure. |
| If you are a limited company, you have to file a tax return along with company accounts. | Being self-employed means you pay your taxes via self-assessment rather than via a PAYE. |
| To start a limited company, you need to register with Companies House and appoint a director. | Being self-employed means that you need to pay Income tax on business profits. |
| A major advantage of operating as a limited company is that if the business gets into financial trouble, then only the company is liable and not the business owner. | The advantage of being self employed is that there is less hassle of filing tax and other documentation. |
| The disadvantage of a limited company is that there is a lot of admin work, complex legal and reporting requirements. | The major disadvantage to being self employed is that there is no legal distinction between you and your company. If your business fails, then you are personally held responsible for any debts incurred. |
| It is difficult to take out money from a limited company. | As the owner of the company, you can withdraw money anytime you require it. |
| Being limited is the most tax-efficient as you pay corporation tax on their profits. | Being self employed means that you need to pay Income tax on business profits. |
| As a limited company, you can extract money through your company as dividends, providing your limited company is in profit | As a self-employed individual, financial benefits such as dividends are not typically available to you |
Tax responsibility as a limited company
- Limited companies pay corporation tax at ‘small profits rate’ or main rate; company directors pay their own income tax on the salary they draw from the company.
- To take advantage of the tax benefits of trading as a limited company, you can choose to pay yourself a low salary and leave the rest of your profits in the business.
- This will reduce your PAYE tax liability and National Insurance Contributions, and you can still pay yourself additional sums in the form of dividends, which do not attract national insurance.
Are you self-employed if you are a limited company?
Both distinctions are indeed quite different, but if you set up a limited company, you are still technically classified as self-employed in terms of the structure of your working status. A sole trader is an easy way to set up compared to a limited company.
Deciding to set up a limited company goes far beyond accounting software or coming up with a name. If you have a new business idea and have not yet formed a limited company, you should begin by deciding what structure you would like your new venture to take: do you want to start a limited company or do you want to start up a partnership?
You must appreciate the various statutory responsibilities that come with incorporation. Anyone who has already set up a company will advise you to seek the support of an accountant before setting out on your venture.
Essentially, it is up to you, but it is always best to ask for guidance from a professional in the field.
What to consider when choosing your business structure
The ‘business structure’ refers to your business’s legal status, which determines how tax is paid on business and personal income and how the business will deal with debt or legal liabilities. There are four common types of business structure: sole trader, partnership, limited company, and limited liability company, all of which come with advantages and disadvantages.
Which you choose depends on your priorities for the business, its type, and how important personal asset protection and outside investment are to your business. If you have valuable personal assets, they could be at risk if your business falls into financial trouble unless you are protected by your business structure.
Although the business structure can be changed from a sole trader to a limited company or vice versa, there could be costs associated with setting up or winding up a limited company, including changing your business stationery and website.
Return to “What is the difference between Ltd. and self-employed?” above. There, you’ll see that a sole trader business is the simplest structure to set up and run, with tax and accounting tending to be simpler. On the other hand, the legal structure of a limited company or partnership protects its owner(s) from personal liability for legal or financial issues.
Business growth
The company structure you decide on will offer certain tax benefits and come with specific responsibilities. However, the business structure will play a part in determining growth and development, which is why deciding on the right structure is crucial. So, what determines the best structure for a business looking for growth?
Raising capital enables your business to expand and become better known. Capital is easier to attract through a limited company. Banks are more likely to agree on business loans; investors are easier to attract; and winning tenders and doing business with public organisations is easier, too. You could raise capital by selling shares in the company. Sole traders don’t have this advantage and rely on personal finances to run their business.
Since the law treats sole traders and their businesses as one and the same, this means that when the business owner dies, the business will die with them. A limited liability company exists as a separate entity from its owner, which means succession planning can play a part.
Liability
One of the most important issues to consider in relation to your company structure is liability: a limited liability company or partnership structure protects your personal assets, whereas a sole trader structure does not.
Your company structure also has a bearing on tax liability, although if your profits are £20,000 or lower, the difference between a sole trader and a limited company structure is not so stark in terms of taxation.
No matter which business structure you opt to trade under, you will be liable to pay UK tax of some sort, report all your income and expenses accurately against profits, and then file and pay what you owe on time.
Tax implications
Sole traders will pay, after the tax-free allowance (£12,570) and any other relief or allowances they may be eligible for, 20% basic rate income tax to 45% additional rate. They also need to pay classes 2 and 4 national insurance contributions. Some sole traders make payments on account, paying part of the following year’s tax bill based on their current year’s profits. Limited companies don’t tend to need to do this.
A limited company, however, will pay corporation tax on the profits at the small profits rate (19% for profits up to £50,00 and 25% main rate for profits over £25,000). After a limited company has paid its tax, dividends may be available to its shareholders.
Dividends are taxed at a lower rate than the income tax rate, and no national insurance is due on them. Limited company directors, therefore, often pay themselves a lower salary under or just above the personal allowance threshold and then make up their wages by taking dividends from the company.
Talk to us about setting up your limited company or being self-employed
Looking for help in setting up as a limited company or choosing which structure to choose? Please feel free to get in touch with us. We recommend taking the expert advice of an accountant before rushing into any decision.
We can offer:
- Prompt and efficient company registration
- Online limited company formation application at Companies House
- Affordable business services with guaranteed banking in the UK and worldwide
At CloudCo, our team has years of industry experience and in-depth knowledge, helping thousands of clients throughout the world. We not only specialise in online limited company formations, but we can also offer you a wide range of formation services.
Our services are apt for varied kinds of companies, including companies that are limited by shares, limited by guarantees, and limited by liability partnerships.
If you would prefer to be self-employed, then we can also offer tax-efficient services as well as general guidance on the rules and regulations of being self-employed.
