One of the questions we get asked most often is about the best structure for operating a small business, with tax in mind.
The short answer is: “It depends, let’s talk it through in detail,” But here’s a quick guide to the pros and cons of each approach.
In broad terms, these are the four main options:
- Sole trader – most common for one-person businesses.
- Partnership – a simple structure for multi-owner businesses.
- Limited company – the most common form of incorporation.
- Limited liability partnership (LLP) – incorporated partnership.
Each of those brings different levels of statutory responsibility and, correspondingly, varying tax liabilities. Now, let’s dig into the detail.
Pros and cons of sole trader status
If you start a business as an individual, you’re a sole trader by default, unless you take steps to change your business structure.
As a sole trader, there’s no distinction between you and your business and any profit you make is classed as personal income. That means that you pay tax on your taxable profits through your self-assessment tax return.
It’s usually pretty simple and straightforward, which is why around 60% of all UK businesses operate under this structure.
What are the downsides of sole trader status? Well, the obvious one is that you might end up paying more through income tax. If you make more than £50,270 in profit in 2021/22, you would end up paying income tax at 40%.
Is limited company status better?
In terms of tax, there’s a definite advantage to incorporating your business. Corporation tax is currently set at 19% in 2021/22 – lower than all three of the income tax rates.
Limited company status also gives us, as your accountants, more tools for managing your tax liability. How so? I’ll explain.
Once you set up a limited company, you become a company director, shareholder, and have the option to become an employee of your own business.
Most company directors elect to pay themselves a relatively small salary, taking further payments in the form of dividends, and perhaps also pension contributions if they’ve got an eye on the long-term.
Get the calculations right (we can help with that) and you’ll make the most of the various tax-free allowances, keep your National Insurance contributions down and swerve those high income tax bands.
That’s not all: the word ‘limited’ refers to the limited liability company directors have should the business fail. As a sole trader, you could lose your house and other assets; as a limited company director, you’re insulated from that personal risk.
Sounds like the obvious choice, right? The problem is, incorporation brings with it a whole raft of statutory responsibilities which some might find overwhelming.
For starters, you need to register with Companies House and HMRC. Then you need to submit a corporation tax return 12 months after the end of your accounting period, whether you made a profit or otherwise, and file annual accounts.
You also need to keep all sorts of additional records, file reports – and publish your personal information online (name, address, date of birth, and so on) where anyone can find it.
You can see why this requires some careful thought.
About partnerships and LLPs
You’ve probably worked out by now that a standard business partnership operates on much the same basis as a sole trader business, except that there are two or more people in charge.
By the same token, an LLP shares many of the features of a limited company. They’re particularly popular for professional partnerships, such as architectural practices, legal firms and consultancy businesses.
The main difference between an LLP and a limited company is that the liability of shareholders in the latter is limited by the value of their shares, while the limit of a partner’s liability in an LLP is based on a formal agreement between the partners.
If you want tailored advice on your business structure, get in touch.