When associated costs are taken into account, you will likely take home more money as a sole trader when your contract earnings are lower. Also, if you are unsure if you will continue working for yourself, it is more difficult and costly to close down a Limited Company, compared to ceasing as a sole trader.
As your contracting career grows, setting up a Limited Company can make sense for a variety of reasons. Perhaps your earnings are increasing and you are looking for more tax efficiency, in order to take home more money. You may find certain clients who will only engage with a Limited Company and not with a sole trader. Or maybe you will be taking on a higher-risk contract and want your personal assets to be protected if something goes wrong. This guide looks at the reasons to set up a Limited Company and the steps you would need to take.
A sole trader pays tax on profits as they earn them, as well as National Insurance on all declared profits. Once you are earning enough – usually around £25,000 per year – it can be more efficient to trade through a Limited Company. You will be able to take advantage of your personal tax allowance, by paying yourself a salary through the company payroll and also a separate tax allowance by paying yourself dividends as a Director – not subject to National Insurance. If income is fluctuating year on year, you can also leave profits in the business and draw them in a year with lower earnings.
Another key part of the tax efficiency in a Limited company is how expenses are treated. Expenses for a sole trader are as simple as keeping a track of your direct business expenditure and including the figure on a self-assessment tax return. A Limited Company benefits from different allowances – particularly claiming 45p per mile for business mileage, instead of vehicle running costs. Other allowable expenses through a Limited Company include:
- Rental payments on business premises
- Business utility bills
- Costs associated with running your business bank account
- Stock purchased for resale
- Equipment or tools required to operate your business
- Travel and accommodation costs, and associated allowances