The decision to change from 'sole trader' to 'limited company' legal status can be tricky to call – especially if you're just getting to that point where you're making enough profit for incorporation to be a viable option.
To help you weigh up the pros and cons, we’ve created this handy guide on the benefits of incorporation versus staying as a sole trader.
Get your free in-depth guide, which explains why a small business might decide to go from sole trader to limited company.
The sole trader legal structure differs from that of limited companies in several key ways.
Read more about the difference between sole trader and limited company.
If you’re already a sole trader, incorporation might be a good step in certain circumstances.
Many small businesses and self-employed people start out as sole traders because it’s the easiest legal structure to set up – especially when you’re keen to get going with your new venture.
But despite more admin, becoming a limited company can bring increased tax-efficiency, as well as limited liability, greater borrowing power, improved reputation, and credibility among clients and customers.
Read our article for tips on choosing the right legal structure for your business.
In time, the profits of a successful small enterprise will start to flow in. At this point, you may want to consider how becoming incorporated could lower your tax bill.
Speak to an accountant or financial advisor if you’re unsure if it’s the right time for your business financially.
Another key benefit of changing from sole trader to limited company is what it could do to boost your business’s image in the eyes of your customers. Incorporation may give you more of a professional edge by showing the world that you're a legitimate setup.
Depending on the nature of your business and the direction you want to take it in, you may also want to bring in other directors, or maybe shareholders. To do this, you’d need to be a limited company.
You can read all about how to set yourself up as a limited company in our article about registering with Companies House.
Here are the key steps you'll need to take if you're changing from sole trader to limited company:
If your earnings stay relatively low, you’ll probably want to keep your tax and accounting as simple as it can be so you can do it on your own, or at least not pay the higher accountant fees that tend to come with being incorporated.
One thing to think about here is whether you need the limited liability aspect of incorporation.
You may want to look into forming a limited company if you increase your earnings. Things to take into account when you’re making this decision include how much profit you’re making and the current rates of tax you’ll need to pay.
The costs associated with being a limited company rather than a sole trader will need to be lower than your profit to make it worth your while, so it’s a good idea to do some calculations before you take this step.
It’s also worth bearing in mind the time and effort involved in bookkeeping and other administrative tasks around being incorporated. However, if you want to borrow money to grow your business, this is likely to be far easier if you change from sole trader to limited company status.
There can be several benefits to switching to a limited company structure, taking into consideration yours and your business’s needs. Here are some of the key ones:
This means you should have a separate bank account to keep all your personal finances separate from those of your business. This isn’t a legal requirement but it’s advised by experts.
Setting up a new account for your newly formed limited company, rather than simply using the one you used when you were a sole trader, will help you avoid any potential nasty tax surprises. You can read our article on the best business bank accounts to help you get started.
As a sole trader you pay tax personally on all the profit you make. It’s generally understood that if you earn up to £30,000 you’re better off staying as a sole trader. When you start to take in more than that annually, it’s probably time to think about whether to incorporate.
If you’re a limited company, you pay Corporation Tax on any profits you make (and you need to do this before you take any dividends). Claiming expenses reduces the profit you make and, therefore, your tax bill.
When you become a limited company you register your business name with Companies House. This means no other company can use it. However, it’s worth noting that if you use a different trading name that’s not registered, another company may use it.
Read more about intellectual property law for small businesses.
Changing from sole trader to limited company can be a tough thing to get your head around on your own, so you may find it’s worthwhile chatting it through with an accountant.
Have you made the switch from sole trader to limited company? Tell us how it went in the comments below.
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