When Should You Move From Sole Trader to Limited Company?

If you’re considering a move from sole trader to Limited Company but are unsure whether this is right for you, then this guide is for you. Here, you’ll find out key issues to consider if you’d like to understand more about when you should move from sole trader to Limited Company.

Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.

What is the Difference Between a Sole Trader and a Limited Company?

A Limited Company is a type of UK business structure that is its own separate business entity. It is responsible for its own liabilities, contracts, money etc.

A sole trader is a person who is not legally separate from their businesses and are responsible for business debts and assets.

Because of the difference in the legal side of things, sole traders and Limited Companies are subject to different reporting requirements and tax rules. This is in addition to there being implications for things like personal assets, paying yourself and the administration side of things.

When Should You Move From Sole Trader to Limited Company?

There is no definitive answer to the question of when it is right to move from sole trader to Limited Company. It’s going to come down to your personal circumstances and what you hope to gain by making the move. Here are some key considerations to help you decide what’s right for you.

Do You Want to Cut Your Tax Bill?

If you simply want to cut your tax bill, then moving from sole trader to Limited Company could help you to achieve that saving. There are many people who set up sole Director Limited Companies purely to take advantage of the tax benefits incorporation can bring.

By structuring how you pay yourself from your Limited Company tax efficiently, you could benefit from dividend tax rates starting at 8.75% and corporation tax of 19% once your personal allowance runs out, instead of income tax rates starting at 20%.

Generally, accountants don’t recommend forming a Limited Company until business profits reach £50,000. This is where the tax savings really kick in and they outweigh the accounting fees you need to pay to help administer your Limited Company.

Read this guide to find out more about Sole Trader v Limited Company tax savings. It includes a calculator to help you work out what will cut your tax bill the most.

Are you OK With Additional Reporting?

As a sole trader, you are legally required to report your income and expenses once a year by filling in a tax return. If your affairs are fairly simple, you may be doing your own self-assessment or paying minimal accounting fees to have this done for you.

Limited Companies have more complicated reporting requirements. So, once you incorporate each year you’ll need to file:

  • Company accounts with Companies House in a prescribed statutory format (including balance sheet, profit & loss account and notes);
  • Corporation tax return with HMRC;
  • Confirmation Statement with Companies House;
  • A personal tax return, detailing your ownership, directorship and salary you have taken.

It’s advisable to use an accountant to take care of your Limited Company reporting. This can also help to make sure you pay yourself in the most tax-efficient way. That way, you’ll take full advantage of the tax savings a Limited Company brings and avoid penalties for missing any deadlines.

Are You a Spreadsheet User?

Many sole traders use a bookkeeping spreadsheet to manage their business finances. Spreadsheets are easier to use and less complicated than accounting software. However, upcoming changes of making tax digital will force many away from spreadsheets.

When you move from sole trader to Limited Company, accounting software like Xero is advisable. It generates all the reports you’ll need to produce Company Accounts for Companies House. And therefore, reduce your accounting bills. But this can bring a monthly subscription cost and time invested in learning how to use the software.

If your tax affairs are fairly simple, switching from a spreadsheet to software may bring more complications than you need.

Will It Be Better for Your Business?

It may be worth setting up a Limited Company if you deal with customers who prefer to deal with suppliers who have an Ltd. And depending on your plans for your business, a Limited Company may give you more credibility with lenders.

It may make sense for you to move from sole trader to Limited Company if you have plans to grow your business. It also applies to target a certain type of client or want to get funding.

Do You Want to Protect Personal Assets?

A limited company is a separate legal entity from its Directors and Shareholders. This means it is responsible for its own debts such as taxes, purchase invoices and loans. However, the reality is that the veil that a Limited Company offers is beginning to disappear in certain circumstances, such as:

  • Banks & lenders are more commonly requesting personal guarantees of loans and overdrafts. This makes you ultimately responsible for paying back debts regardless of Limited Company status;
  • If you were considered to be doing anything wrongful or fraudulent by HMRC or Companies House as Director of a Limited Company, it’ll become your responsibility to repay and rectify any issues;
  • If, as a Director, you were deemed to have taken out too much money either by your directors loan account or dividend, you’d be required to repay the money putting your personal assets at risk;
  • Or, if you were trying to wind up your business without paying taxes. HMRC has the power to prevent you from shutting down your Limited Company until you pay the unpaid amounts.

Final Thoughts Before You Move From Sole Trader to Limited Company

Going from sole trader to Limited Company is right for some people but others, despite the tax savings, still prefer the simplicity of staying self-employed. If you don’t quite feel ready to make the change, then you could consider forming your Limited Company now and filing dormant accounts. That way, just like saving a domain, you have saved the name of your Limited Company to use in the future when things are right.

If you are considering forming a Limited Company just to make tax savings, then try my calculator to help you check what money you will save. Generally, however, accountants don’t tend to recommend forming a limited company until your taxable profits reach around £30,000 per year.

Ready to take your business to the next level and form a Limited Company? Take a look at my recommended Company Formation partner 1st Formations, where packages start from £12.99.

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About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek and money nerd helping financial DIY-ers organise their money so they can hit their goals quicker.

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