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Choosing the right legal structure for your small business will give you peace of mind. The peace of mind that you and your personal property are fully protected but also that you make the best possible tax savings.
If you are new to business, then understanding what types of legal structures are available to you can be confusing. So here are the main legal structures available for small businesses in the UK.
Self-employed or Sole Trader
This is by far the easiest and quickest way to start your business. As soon as you decide you are going to start a business just pick a trading name and you can begin marketing.
You need register as self employed with HMRC to let them know you are in business.
Then file self assessment tax returns by 31 January each year so they know how much money you have made and how much tax you need to pay.
Tax When You Are Self-Employed
You will pay income tax and national insurance based on the profits of your business.
- The quickest way to start trading;
- There are very little setup costs, as it is a simple business structure;
- You are only required to submit a tax return each year under self assessment, so the paperwork for letting HMRC know how much tax you owe is fairly minimal by comparison to other business structures.
- Unlike an employee in a salaried job, you can deduct expenses from your income like travel and use of home, thereby the amount of income you actually pay tax on.
- You are personally liable for the debts of the business as there is no separation between you and the business, so it puts your own money at risk or even your house;
- Although the tax is more straightforward to calculate you can find yourself paying a more tax than if you operated through a limited company.
Generally, accountants don’t recommend forming a limited company until your taxable profits reach around £30,000 per year. But you may want to incorporate a Limited Company for other reasons
Forming a Limited Company and being a Company Director can be a prestigious move. it will give you and your business credibility especially if you are chasing after large contracts and projects. As your business grows so too will the credit rating of your Limited Company which may help if you wanted to borrow money or search out funding.
However, forming a Limited Company does bring with it more administrative duties and cost. So always get the right advice before forming a limited Company and make sure you understand the implications.
Once you have decided to form a Limited Company, it will need to be registered at Companies House – make sure your chosen name is available because every name registered must be unique.
A Limited Company is a separate entity to you, so it has its own set of finances and owns all the profit it makes. You will be a Director and Shareholder. As a Director you are responsible for running the Limited Company to the best of your abilities and you can elect to pay dividends to its shareholders (which just means that the Director decides how much of the Company profits will be paid to its shareholders).
You also need to file annual accounts with Companies House and a Corporation Tax Return with HMRC.
Taxes for a Limited Company
A Limited Company pays corporation tax at 20% on the first £300,000 of profits. You then need to extract your money from the profits and pay income tax on this money as well.
- Limited Liability status means you are not personally responsible for the debts of the Company;
- Improved credibility in the marketplace;
- Depending on your earnings, incorporating could save you tax.
- Can be set up costs for forming your Company and completing all the necessary registrations;
- Increased administrative burden and costs attached to this of filing returns each year for the Limited Company;
- Still required to submit a personal tax return through self-assessment by 31 January each year.
If you are considering going into business with a colleague or friend then setting up a partnership may be the ideal legal structure. It is very similar to being self employed, but there will be a partnership agreement which sets out:
- How profits will be split
- How costs will be split
You will need to let HMRC know that you are in a partnership and nominate the partner who will be responsible for the partnership tax returns and administration.
Each partner will need to submit a self assessment tax return by the 31 January each year, detailing their share of the profit and notifying them of the tax you need to pay on this profit.
Tax When You Have a Partnership
You will pay income tax and national insurance (class 2 + class 4) based on your share of the profits from your business.
Income tax is currently 20% on profits up to £32,000 rising to 40% between £32,000 and £150,000;
Class 2 National Insurance is currently £2.80 per week where annual profits are in excess of £5,965;
Class 4 National Insurance is currently 9% on profits between £8,060 and £43,000, then at 2% thereafter.
- It is a relatively quick way to start trading once you have your partnership agreement in place;
- You are only required to submit a tax return each year under self assessment, so the paperwork for speaking to HMRC is fairly minimal by comparison to other business structures.
- You can share the cost and responsibility of starting a business with someone else;
- There is more than one person to put start up capital into the business, give your new venture a better start.
- Although you have an agreement on how to split costs, you can find yourself liable for bills which you did not agree to;
- There is always the risk of falling out with your partner especially if you have never worked together before;
- Each of the partners are personally liable for the debts of the business putting your own belongings at risk;
- As your new venture begins to succeed, the personal tax can start to be more than if you operated through a limited company.
Limited Liability Partnership (LLP)
Limited Liability Partnerships are a relatively new legal structure. Unlike a traditional partnership this choice of legal structure means the partners are not personally responsible for the debts of the LLP.
Taxes for an LLP
There is no change to the way you are taxed in an LLP from a traditional partnership. Partners are still required to declare their share of income in a self assessment tax return in accordance with the Partnership Agreement.
- Limited Liability status means the partners are not personally responsible for the debts of the Company;.
- Tax is still paid through self assessment so a partner can find themselves paying more tax than if you operated through a limited company.
Choosing the right legal structure will not only protect you but could save you tax.
If you are unsure what legal structure is right for you or are working with business partners, then seek professional advice to help you decide what is right for you.
Anita is a Chartered Accountant with over a decade of experience taking self-employed business owners from financially confused to business savvy.
She is the creator of the ‘Go Self Employed’ website, which is her corner on the internet where she makes self-employment less terrifying.