Self Employed Or Limited Company?
We are asked almost daily whether it would be best to be a sole trader (it means the same as self-employed) or start a limited company. There are several issues you need to understand before coming to a decision about what works best for you.
For the self-employed all profits are taxable in the year they are earned, in addition to any other sources of income. There is no flexibility for deferring some of those profits to another year if you happen to have a particularly good year and are taxed at the higher rate.
Limited Companies are taxed on their trading profits also, in addition to other sources of income such as interest and rent. Corporation tax at 19% is assessed on the profits for the year. But there is flexibility on when income is taken out of the company so some profits can be retained in the company if the owner would otherwise be likely to pay higher rate tax personally. The income is usually largely dividends on which no National Insurance Contributions are charged. And the dividend rate is considerably lower for basic rate taxpayers.
Why Should I Think Of Incorporating?
There are several reasons for forming a limited company:
- In some sectors (such as IT), it is hard to obtain contracts unless you trade through a limited company. There is not always an obvious reason for this; it is just the way things are.
- If you are taking risks such as in ordering large stock for an order which could be cancelled, then there can be a real benefit in the limited liability offered by trading as a company. Your own personal possessions are generally protected from any claim against the company. However, in some circumstances, taking out a good insurance policy is all you need.
- There is more flexibility in handling the owner’s remuneration in such a way as to minimise the tax liability. And using different classes of shares makes the tax position potentially even more favourable.
- If you require external investment then a company provides the structure to separate investors (shareholders) from directors and employees.
What Are The Disadvantages?
Your accountancy costs will increase if you run a company, so you will need to be convinced that there are sufficient savings to justify the cost. The company will be regulated by Companies House, which has strict rules for reporting trading accounts (hence the increased costs) and for the conduct of directors and other company officials. You will need to be comfortable with the increased level of complexity and responsibility.
Can I Change From Self Employment To A Limited Company?
Yes. You can start as a sole trader and later incorporate. In fact, this is a common route when a new business is unsure of how large it will grow and whether the saving will outweigh the costs. If you make an initial loss being a sole trader may be able to offset the loss against employment income in the same or previous years and obtain a tax rebate.
Much will depend on your particular circumstances so you will need to consult a professional to ensure that any set up and transition is done properly.
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