Becoming a Sole Trader (self-employed) is the simplest way to run a small business, especially if you’re just starting out. Many contractors and freelancers - including animators - operate as Sole Traders at the beginning of their careers. As a Sole Trader you will be operating your business as a self-employed individual.
Setting-up as a Sole Trader is generally a simple process and it is much easier than setting-up a Limited Company. All you need to do is inform HMRC of your intention to become self-employed, and you can start trading immediately.
Are there risks in being a sole trader?
Yes. There is an element of personal risk involved because as a Sole Trader you are personally responsible for the debts of your business.
What is involved in being a sole trader?
- Annual tax return to HMRC - very simple. Just add up your income and expenses
- No set-up costs - super simple
- Increased personal risk - you are fully liable for all debts
- (Possibly) fewer tax benefits than being a Ltd Co
A Limited Company is a company which is legally separate from the directors who form it. It might have your name in it, but it is a separate legal entity. If the business goes bust, you're not personally liable, except in extreme circumstances like fraud or illegal trading.
What is involved in becoming a limited company?
- Set-up costs. These aren't too great - a few hundred pounds.
- Registration and filing of annual statutory accounts with Companies House. This is a pain and costs extra as you will need to get an accountant to do this for you every year.
- Annual tax return, corporation tax return to HMRC. Again, pain in the neck.
- Very little personal risk - if the company goes bust, its creditors can't come after you personally. Mostly.
- Higher accountancy fees - and more complexity.
- May save you some tax, though HMRC change the rules all the time.
Individuals and companies are taxed differently. Companies pay corporation tax, which, right now in the UK, is 23% (it's higher in the USA). By contrast, as a sole trader, your trading profit is taxed as income tax. That is to say, 20% at the basic rate (up to around £43,000), 40% at the higher rate and then 45% if you make over £150k per annum.
It is very important to remember that a company is legally separate from you as an individual. The company's profit after tax belongs to the company - not to the owner. To get the money out of the company, it has to be distributed, either by way of a salary or a dividend. And, once you pay yourself a salary or dividend, you won't be surprised to learn that more tax is payable.
You also have to consider, at least in the UK, the complicated rules for National Insurance contributions when you set up a company. National insurance is - in theory - an insurance scheme which will look after you in your old age. In practice it is just another tax.
So why become a company if there is all this tax and hassle?
Good question. The big advantage of being a limited company is that bigger companies are likely to prefer dealing with you this way. Large companies often will only do business with Limited Companies - not Sole Traders. But, if you want to keep your life simple, just stay as a sole trader.
Also see our post here about the benefits and burdens of setting up a limited company.