The main reason most sole traders switch to a Limited Company is simple – tax advantages and the resulting increase in take-home pay.
A sole trader uses standard income tax bandings for all income – after expenses, they are essentially taxed as an employee. As profits increase, this can be increasingly costly.
A Limited Company pays dividends and salary. This means that by working via a Limited Company, your can draw a small salary within your personal allowance, paying no personal tax and minimal National Insurance. Dividend income is taxed separately and not subject to National Insurance.
There are generous tax breaks available to Limited Companies when paying into a pension. This means that, in addition to paying less tax on your immediate income, you can also save additional tax on the income you choose to save for retirement. You can read our contractor pensions guide for more information click here.
A Limited Company is a separate legal entity and as the name suggests, your liability is limited in the event the business acquires genuine debts or makes a loss. As long as no fraud has taken place and you have used to company’s money wisely, only your company’s assets are at risk. If you are operating as a sole trader, you are personally liable for any losses made by your business – so you are risking your personal assets if things go wrong.
It might seem unfair, but a Limited Company often has greater credibility in the eyes of clients and suppliers. Being the Director of your own Limited Company can make it easier to secure contracts, make your business appear bigger than it is and make your company appear more reputable. Indeed, some organisations will only deal with Limited Companies and won’t engage with a sole trader.