The age-old question on “how should I work as an independent professional?” has been around forever. Throughout 2020 and 2021 the market was faced with many changes due to Covid-19, IR35 and just the general struggles of supply and demand. This has put an even bigger spotlight on exactly what the most beneficial way of contracting is.

Now, not everybody knows where to start – whether being a sole trader or limited company would suit them better. In this guide we will be highlighting the differences between each status and importantly, which could work out the most tax efficient route for your business.

What is the difference between. . .

Self-Employed

This is a more generic term. Self-employed is a term that relates to the way that you work, rather than your business structure. You won’t receive sick or holiday pay but you are completely in control of the work that you choose to do i.e. you are not employed by somebody else. As a self-employed person you can choose the business structure that will work best for you, be that sole trader (or business partnership) or a limited company.

Sole Trader

Being a sole trader means you are the sole owner of a business and you and your business are considered as one combined financial and legal entity. Because this is the simplest way of working it is also the most popular. It’s worth noting here this is identical to a business partnership except with a partnership the business is shared between two or more owners.

Limited Company Contractor

If you have a limited company it has its own legal identity, separate to you, the owner and any directors. This means your personal finances are protected. Every limited company must be registered with Companies House. Turning your business into a limited company is also known as incorporation.

What are the advantages of being…

A Sole Trader:

• It is very simple to set up as a sole trader with comparatively little paperwork.
• Having less paperwork usually means that your accounting is a little simpler and there is less bookkeeping to be done. Once a year you will need to add up all your income and all your expenses and submit these figures to HMRC on a tax return.
• You have more privacy as your business information and earnings are still private to you as you don’t need to register with Companies House.

A Limited Company:

• Because your company is legally considered a separate entity, you have limited liability which means your personal finances are protected. The only finances at risk are those in the company.
• The name that you will register with Companies House is yours and yours alone, nobody else can use it and it is protected by law.
• Generally speaking (although this can vary depending on your business area), limited companies are more tax efficient due to the fact you will pay corporation tax on your profits rather than paying income tax. Our Contractor Take Home Pay Calculator can break down how much you would take home based on a few expenses to help provide a clearer idea.
• Limited companies can claim a wide range of allowances and tax-deductible costs against its profits. Our full Guide to Limited Company Expenses can be found here.
• You may be able to command a higher rate of pay. Some businesses only like to deal with other limited companies as they can be considered more professional and therefore in a position to charge more.
• Through greater tax planning opportunities, you can legitimately pay less personal tax. This is dependent on how much you earn, but often considered the biggest advantage over being a sole trader. As a sole trader you would pay 20-45% income tax on profit, as a limited company you’ll pay 19% corporation tax (the current rate).
• You can pay yourself through a combination of salary and dividend. This is the most tax efficient combination due to the fact that you don’t pay national insurance on dividends, taking a small salary will automatically trigger a national insurance record for your state pension, and you can minimise your personal tax liability. More information on contractor dividends can be found here.
• It will be easier to get investment from banks and investors, and it will be relatively easy to sell shares to investors should you wish to do so.

What are the Disadvantages of being…

A Sole Trader:

• Probably the main disadvantage is that you have unlimited liability i.e. because you and your business are legally considered one and the same, if your business gets into debt, you, as the business owner, is personally liable and could lose personal assets such as your house or car.
• It can be difficult to raise finance as investors and banks favour limited companies so expansion opportunities can be restricted.
• Once you reach a certain amount of earning, remaining a sole trader won’t be as lucrative due to higher tax rates.

A Limited Company:

• It can be more costly and time-consuming due to the larger amount of paperwork involved and accountancy fees are likely to be a little more expensive due to the increased volume of work. There is also a (albeit small) fee to register your company.
• You will have more responsibilities known as fiduciary responsibilities – these outline the legalities of what you, as a company director, must do.
• You will have less privacy as, once you’re registered with Companies House, information about your business and its earnings can be viewed by the public, as well as your office address (although you can use your accountant’s office address rather than your own).

Is there a good time to switch from being a Sole Trader to a Limited Company?

You might want to consider switching from sole trader to limited company once your profits start increasing as you will be wanting to lower your tax bill. Your accountant will be able to advise you as to the best option for you and your business and work out if it will be financially beneficial to do so. As a benchmark, we recommend if profits are expected to exceed over £30,000 then switching from sole trader to limited company will be more tax efficient.

What other trading options are available?

Being a sole trader or limited company aren’t your only options so let’s have a quick look at Umbrella Companies and SME’s.

Umbrella Companies

Umbrella companies don’t find work for you, but what they do is employ contractors (or any self-employed individual) on behalf of an employment agency or client.

You become an employee of the umbrella company for the period you are working with them, which means that the agency or client will pay them and they will deduct all the necessary PAYE and NI contributions before paying you (the contractor) your salary.

You might consider working with an umbrella company for the associated employment rights. In addition, your tax is calculated, deducted and paid by the umbrella company meaning less paperwork for you. It’s a simple way to work on temporary contracts and because you are an employee, IR35 isn’t an issue.

Bear in mind though that because you are on the payroll, your take home pay will usually be less than if you are working as a limited company. You’ll also have less control over your finances.

If you do choose to work with an umbrella company, make sure you do your due diligence as there are a number of non-compliant umbrella companies operating. We recommend fully FCSA accredited umbrella company Clarity Umbrella – rated 5/5 by clients and offering same day payments as standard.

At Integro Accounting we offer an accountancy and payroll package called Easy Switch – this allows you to switch between an umbrella company and your own limited company to suit your latest contract at no extra cost! Just £110 + VAT the same as our standard accountancy package.

SME’s

An SME is a small or medium-sized business with fewer than 250 employees and make up 99.9% of businesses in the UK. Under the heading of SME there are three categories – medium, small and micro and are defined by number of employees and turnover.

Talk to an expert

We all want to maximise our take home pay and reduce our tax bill where possible, so make sure you take advice about which route will be the most efficient and profitable for you. Our fully qualified team of accountants are always on hand to discuss this further, so feel free to call them on 0207 096 2659 or email christian@integroaccounting.com to explain your question.

Making sure you make the right decision from the outset gives you and your business the best foundation from the start.