If you’re already a sole trader and your business is growing, you might want to consider setting up a limited company instead.
As a sole trader, your accounts and tax responsibilities are usually quite straightforward, but if your profit increases to a certain level, it can make more sense from a tax point of view to move to a limited company business structure instead. Everyone’s circumstances are unique, so there is no set rule about what level of profit this might be, but many sole traders find that after their profits start to exceed around £50,000 a year, it can start to be most cost-effective to trade as a limited company instead.
It’s important to note that your accounting and tax responsibilities do change significantly when your business becomes a limited company, so we have overviewed some of the main differences in this article.
As a limited company, your business finances are separate to your personal finances
When you become a limited company, the money that comes in and out of the business is totally separate to your personal finances. This is because, as a limited company, you are not personally responsible for the business finances.
Limited companies need to have a bank account under the name of the business. Many sole traders choose to do this too, but it’s not a legal requirement. However, as a limited company, it’s essential to do this to help avoid tax consequences.
Your salary or business income is handled differently with a limited company
With a limited company, even if you are still a one-man-band, the most tax-efficient way to pay yourself is usually through a combination of salary and dividends. Dividends are taken from the company’s profits after the Corporation Tax due has been paid.
There can be a complex balance to find when it comes to working out the ideal salary and dividend payments for your specific situation, so it can be useful to speak to a professional accountant to ensure you make informed decisions on this, based on your individual circumstances.
Corporation tax is calculated differently to income tax, so keeping all business and personal finances totally separate is essential if you’re running a limited company.
Keeping on top of day-to-day bookkeeping is essential for limited companies.
More tax returns to file when you’re a limited company
As a sole trader, you may well have only been submitting an annual self-assessment return to HMRC. As a limited company director, you’ll still need to submit self-assessment returns, but will also need to file payroll monthly (for the salary you’re paying yourself). The dividends you receive from the company need to be declared, along with any other income sources.
The limited company needs to file accounts and returns to HMRC and Companies House annually and, if you are VAT-registered, you’ll also need to file VAT returns.
This can seem like a lot of work and effort in terms of the amount of paperwork and admin required, as well as keeping on top of bookkeeping and accounts, but if you outsource this to an experienced accountant, it can take away most of the burden and free most of your time back up to run the business instead.
Expenses are treated differently when you’re a limited company
There are some different kinds of business expenses that you can claim tax relief on as a limited company that you are unable to claim if you are a sole trader. This can also be more tax efficient, depending on the circumstances and the nature of the expenses.
Summary
There are some fundamental changes to your accounting and tax responsibilities if you choose to change from a sole trader to a limited company, and there are pros and cons to both types of company structure.
Getting expert advice that is tailored to your individual company and situation is essential in order to have all the information you need to decide on your next steps and whether you should make this switch.
We can provide specialist support so that you can make key decisions like this about your business with confidence. We can also help with your company formation and ensure that you are managing your business in the most tax-efficient way. Our bookkeeping and accounting services can take away the admin headache and ensure that you’re able to meet your obligations to HMRC and Companies House within deadline.