Pros & Cons, how to set up
Sole Trader
A sole trader is a self-employed person who is the only owner of their business and runs the business as an individual. You keep all your business’s profits after you’ve paid tax on them and you’re personally responsible for any losses your business makes. There is no legal separation between you as the business owner and the business itself.
When it comes to naming your business, you have the option to either trade under your own name or a business name. But when it comes naming your sole trader business, other businesses can trade under the same name as you.
In the eyes of the law, sole traders don’t have a separate legal existence from their business, meaning any business decisions, profits and debts are the responsibility of the owner. So, for example your business was to fall into debt or fail, as the business owner you’d be personally liable or if your company is involved in a legal dispute, you’ll be sued personally.
As a sole trader, the money you withdraw out of the business is treated as salary and you need to pay National Insurance and submit a personal Self-Assessment Tax Return to HMRC at the end of each tax year.
Sole traders can operate completely privately and aren’t required to make any information on their business accounts, records, directors and shareholders public.
Sole traders can operate completely privately and aren’t required to make any information on their business accounts, records, directors and shareholders public. The responsibilities are much less than those required of Limited Company Directors, this is probably one of the main attractions of being a sole trader.
You’ll need to:
keep records of your business' sales and expenses
send a Self Assessment tax return every year
pay Income tax on your profits and Class 2 and Class 4 National Insurance - you can use HMRC's calculator to help you budget for this; https://www.gov.uk/self-assessment-ready-reckoner
You can also choose your accounting method;
Traditional (accrual method) accounting - where you record income and expenses by the date you invoiced or were billed.
Cash accounting - With this method, you only record income or expenses when you receive money or pay a bill. This means you will not need to pay Income Tax on money you have not yet received in your accounting period.
Most small businesses with an income of £150,000 or less can use cash basis reporting.
Sole trade is the most popular type of business in the UK, figures from 2018 showed that of the UK’s 5.6 million small businesses, 3.4 million of them were sole traders.
Setting up as a sole trader is simple, which is probably why it’s the most popular business structure. To become a sole trader you need to have a National Insurance number and inform HMRC by registering for self-assessment.
Limited Company
A limited company is a distinct legal entity from the business owner that can be formed whether you’re a one-person business or have employees. By forming a limited company, you serve your business as its director.
Once you register your name with Companies House, your company name is protected by law, meaning no other business can use the same name as you or anything deemed to similar.
As director, you’re responsible for the legal and financial decisions your business makes, but your business’s assets and liabilities are totally separate from your own individual finances. This means that all profits and losses belong to the company.
As a director, you have responsibilities to HMRC and Companies House;
keep company records and report changes
file your accounts with Companies House
file your corporation tax return with HMRC
pay corporation tax to HMRC
Limited companies are required by law to be transparent. Information on company records, accounts, directors and shareholders has to be shared on the public register at Companies House and can be accessed by anyone.
You can hire other people to manage some of these things day-to-day (for example, an accountant) but you’re still legally responsible for your company’s records, accounts and performance.
Companies House and HMRC have different deadlines depending on your accounting year end. Also, Directors of limited companies need to submit a self-assessment of their personal income and allowances to HMRC. This personal tax return must include information about all income gained from employment.
Set up is not free but very quick and easy, there is a small fee (£12) to Companies House for a standard company. If you need a more specialized structure or advice there are formation agents but they charge a higher fee.
Directors have options on the different ways of extracting income from their business – dividends or salary. You can choose how much to withdraw from the business and when, and how much to leave in there as the company’s reserves.
Limited companies are required by law to be transparent. Information on company records, accounts, directors and shareholders has to be shared on the public register at Companies House and can be accessed by anyone.
Pros & Cons – summary
Sole traders are easier to set up and have less responsibilities, so is often more attractive at the start. However the lack of business name protection can be a big draw-back, I know people who have picked a business name and later on have had problems with other people also setting up under the same name.
Tax efficiencies; if profits are under £50k, it tends to be more tax efficient to be a sole trader, for profits over £50k then tends to be more efficient to be a limited company, however the differences can be very small.
Being a limited company gives you more control over how much profit you extract, and when.
Switching from a sole trader to a limited company is very easy, you just stop trading as a sole trader and start trading as a limited company, just be careful with the cut off period and make sure you don’t duplicate or miss out any transactions in your reporting.
Going from a limited company to a sole trader is not so easy, you would have to make the company dormant or shut it down.
What are allowable expenses for business purposes when working from home?
With most of the country being asked to work from home during lockdown, it's relevant to know what tax relief you can claim when working from home. And there are different scenarios for sole traders and limited company directors.
Sole traders
Working from home means you can claim part of your household costs as allowable expenses for tax purposes. The amount you claim should be based on the proportionate use of your property. The main factors to consider are time and space. During this tax year, with so many people working at home more than usual, both these factors are likely to be higher than normal.
A popular method for calculating the amount of space used is to simply take the number of rooms that are used for the business. However, if you have a very small property then it’s likely your work space is not confined to a particular room. It’s likely that when you’re working you’re using the whole space and when you’re not working, you’re using the whole space. So basing the claim on time can be more appropriate.
A self-employed person working from home is entitled to claim a proportion of most household costs, including;
Mortgage interest or rent
Council tax
Water rates
Repairs & maintenance
Insurance
Gas/heating costs
Cleaning
Limited Company Directors
Company directors and other employees can only claim the specific additional cost of working from home – generally just heating and lighting. Where it is impractical to calculate the exact costs, an amount of £6 per week is permitted.
They must also be required to work from home, simply choosing to do so is not enough. Eg. if you run your company from home and have no other business premises, this is a pretty obvious need to work from home. However, in other cases you will need to demonstrate a genuine need to carry out your duties at home.
However, during the recent lockdown, it is clear that many company directors were required to work from home under Government guidelines and so most small company directors should be able to claim this deduction – either at £6 per week, or a greater amount if detailed calculations support it.
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