Incorporating a Sole Trader Business: Pros and Cons
Posted on 23rd October 2023
Are you a sole trader considering incorporating your business? It's important to understand the benefits and limitations that you are exposed to when operating through a limited company. Being informed on the ramifications of incorporating will allow you to make a measured decision on whether moving from sole trader to limited company is the best choice for you.
Understanding Sole Trader vs Limited Companies
Sole traders and limited companies are both valid legal structures for running a business. There are significant differences between the two regarding liability, tax and filing obligations. Understanding the basic differences between the two is vital to ensure you make the correct decision about incorporating.
What is a Sole Trader Business?
A sole trader business refers to an individual running their own self-employed venture. They are personally liable for the business's debts and obligations. Sole traders must register to pay income tax through HM Revenue and Customs' (HMRC) Self Assessment tax return process which involves filing a tax return before the 31st January the following tax year. Aside from this there are very few other parts of paperwork necessary.
Sole Traders must still register for VAT if their taxable turnover reaches above £85,000 in a twelve month period, not their accounting year, but do not pay corporation tax on profits and do not have to submit accounts to Companies House.
What is a Limited Company?
A limited company is a separate legal entity from its owners, providing shareholders with limited liability for company debts. This is an important legal distinction from sole traders who bear the full responsibility for their business and its debts. Limited companies are run by a director ,or directors, who make the decisions for the company and are entitled to dividends from the company's profits.
The director(s) of a limited company must file an annual company tax return and pay corporation tax on profits. VAT registration is the same as for a sole trader as it is only applicable above the VAT turnover threshold.
The Advantages of Staying as a Sole Trader
Simplifying your business operations and maintaining control are the key advantages of staying as a sole trader. When operating as a sole trader your personal information remains private and you retain the freedom to make decisions quickly and efficiently. The flexibility of being your own boss allows you to work on your terms and adapt quickly to changing market conditions, with less admin to worry about.
Simplicity and Control in Operation
Running a sole trader business offers simplicity and control, allowing you to make quick decisions independently. You have complete control over all aspects of your business, with minimal bureaucracy and fewer legal obligations. This flexibility enables you to adapt and change your business strategy in response to the market for your goods or services.
The lack of paperwork compared to a limited company may also save you time and money enabling you to spend more time focusing on your business rather than tedious paperwork and record keeping.
Privacy and Confidentiality
Another advantage of being a sole trader is the privacy that it affords you. As the director of a limited company you must provide your details and a contact address that it part of public records as well as filing returns each year that can be accessed on Companies House. Operating as a sole trader avoids this and allows you to keep your business and its activities to yourself.
The Benefits of Incorporating a Sole Trader Business
By incorporating into a limited company you will have to forfeit some of the above advantages to being a sole trader, but in return you reduce your personal liability, potentially pay less tax, open new avenues of financing your business and potentially enhance your reputation.
Increased Tax Efficiency
Operating your business through a limited company allows you greater freedom over managing your taxes. Once you have paid corporation tax on profits you are then able to decide whether you wish to draw a salary from your company or take out profits as dividends throughout the year.
In addition to this decision you may also choose to retain profits within the company and defer tax liabilities. There are also a plethora of other tax saving possibilities which a tax specialist can outline to you with knowledge of your specific situation. To ensure you maximise these tax benefits and stay compliant with tax laws, it's important to consult an accountant with expertise in small business and contractor accounting.
Limited Liability and Protection for Personal Assets
As a business owner, it is essential to consider the benefits of incorporating for your personal liabilities. The limited liability and protection it provides for your personal assets is a huge benefit for you. By creating a legal separation between you and your business, you shield your personal savings, property, and investments from any business debts or obligations. This ensures that your personal finances remain unaffected by any potential losses your business may incur.
Potentially Enhanced Business Reputation
Establishing a limited company can potentially lead to an enhanced reputation for your business. By incorporating, you gain credibility and trust among customers and suppliers, showcasing your commitment to professionalism and transparency.
Businesses may trust a more professional looking business and by incorporating it allows you to establish a reputable brand that potential clients or customers are able to verify.
Greater Access to Credit
Greater access to credit is yet another benefit of incorporating. Lenders prefer to offer loans to limited companies than sole traders as the perception of risk is lower. This allows you to access higher credit limits, more favorable terms, and the ability to expand your business operations.
The Potential Drawbacks of Incorporation
While incorporating a sole trader business can have its benefits, it's important to consider the potential drawbacks as well. Being the director of a limited company will mean you are obligated to file the correct paperwork, such as annual accounts and confirmation statements, with HMRC and Companies House annually. An accountant can help you with this and will be able to guide you through exactly what is required.
Depending on the type of sole trade business that you have you may need to transfer your sole trade assets into the business. This could include things such as stock, machinery, equipment and property. You should be aware that transferring some business assets can create a Capital Gains Tax liability based on the market value of the assets. This liability, if there is one, can often be reduced or even deferred by claiming available tax reliefs, including Incorporation Relief.
Is Incorporation the Right Move for Your Business?
You must take into account a multitude of factors, some of which are mentioned above, when deciding if you should incorporate. Consider consulting with an accountant who will be able to talk you through your specific situation and advise you on the best business structure for your business.
Get in touch with Sherwin Currid today to discuss incorporating a sole trade.
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