One of the first major decisions that a growing business will need to make is if or when to incorporate from a sole trader into a limited company.
The pros and cons of each take careful consideration, and the decision regarding what trading style to use will largely depend on the type of business, the needs of the business, the speed of growth and the tax savings available compared with the professional fees involved with each.
Self-employed sole trader
As a self employed individual all profits are taxed on the sole trader as an individual in the tax year in which they arise. In the UK, our taxation system is progressive so, as profits increase, the top slice of income may fall into a higher tax band and that portion of income would be taxed at a higher rate.
The current bands and applicable tax rates on indicative £100k of profits, are as follows:
The point at which profits received personally exceed £100k become very tax inefficient, because for every £2 of profit over £100k, the personal allowance (of £12,570) is tapered down by £1. Therefore, once profits reach £125,140, the personal allowance has been completely tapered down to nil.
Another point to note is that no protection is available to sole traders in respect of debts, lending and finance agreements within the business (i.e. the sole traders’ liability is not limited and they will always be held personally responsible for payments of these debts).
The plus side is that the filing requirements for sole traders are minimal. You would only be required to file a self assessment tax return, therefore professional fees are minimal.
It is therefore often beneficial for taxpayers to start their business journey as a sole trader, to keep admin and fee costs to a minimum, and to consider incorporating into a limited entity at a later date.
