Why would someone want to change from being a sole trader to a limited company?

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Hey there - from what I’ve seen on the web, it appears as though the natural progression in the life of a company is to start as a sole trader, then incorporate as a limited by shares company. Why would a sole trader want to change to a limited company? Please advise.

Answers

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There is no need to start your business as a sole trader. You can go straight into business as a limited company, but some people prefer to operate as a sole trader because it’s a much simpler structure to set up and run. However, the reason why so many sole traders progress to the limited company structure is because it is more tax efficient, it can improve their professional status and their personal finances are protected by limited liability.

Tax efficiency

In terms of tax efficiency, a limited company is better because you will only have to pay a flat rate of 20% Corporation Tax on your profits, whereas sole traders have to pay Income Tax between 20-45%, depending on how much they make. Sole traders also pay Class 2 and Class 4 National Insurance on their profits.

A limited company enables the business owner to take some of their income as a director’s salary and the rest as shareholder’s dividends. You can reduce your personal tax liability by taking a small salary below the National Insurance threshold or your Personal Allowance threshold. Dividends are tax free, so the only tax you will pay on these profits is 20% Corporation Tax.

Professional status

In terms of professional status, a limited company is looked upon more favourably by other companies who you may be looking to do business with. Obtaining finance is often easier as a limited company, and clients often feel more comfortable dealing with companies because they appear more established and credible.

Limited liability

The personal finances of company owners are protected by limited liability. If the company faces financial difficulty, the owners are not responsible for business debts. They are only liable for what they pay for their shares or guarantee to contribute in such circumstances. As a sole trader, your personal finances are not protected because you are responsible for all business debts.

If you want to find out more about setting up and running a limited company, please read our online guide.

a year ago
 

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