Should I incorporate?

As an accountant I often get asked whether it is better to trade as a sole trader or limited company. Although the advice varies according to individual's specific requirements there are some general elements to take into consideration.

What is incorporation?

Incorporation is the process of setting up a Limited Company for the business to trade as. This creates a separate legal entities for yourself and the business meaning the company has it's own identity and tax obligations.

Incorporation can have many benefits as discussed below:

Limited Liability

By creating a limited company and separating the business from yourself it allows you to safe guard your personal assets and finances. If the company enters into financial difficulty then your liability is limited to the capital that you have invested in the shares.

Caution needs to be taken however when giving personal guarantees on behalf of the business. Many banks or building societies request these when providing loans or overdrafts to the company however these risk exposing your personal finances and assets until the loan is repaid.

Profits

The profits of the business may mean that it is more favourable to trade as a Limited Company rather than as a Sole Trader as company tax rates are lower than individual tax rates.

Company tax rates are 19% on profits up to £300,000 whereas individuals pay basic rate tax at 20% on income up to £50,000 (excluding personal allowance) and 40% on income up to £150,000.

Unlike a sole trader the Company is taxed on all the profits and you are taxed on the income that you receive from the company. This can reduce the overall tax liability however if you are drawing all the company profits then you shall be taxed twice on the income received.

Tax Planning

There are different tax rates and reliefs for different types of income. By forming a Limited Company it allows you to draw money from the company in the most tax efficient method.

A common approach here is for directors to receive a minimal salary under PAYE and then to receive additional income as dividends. This ensures that you still receive your National Insurance stamp whilst also taking advantage of the £2,000 dividend tax free allowance and the lower dividend tax rates.

There may also be scope to add a partner to the company as a director or shareholder so that they may also receive an income.

Admin Responsibilities

The major downside to forming a Limited Company are the additional admin responsibilities involved. Unlike a Sole Trader, a Limited Company has to prepare formal accounts for filing with Companies House and HMRC as well as completing an annual Confirmation Statement. These additional responsibilities are not only more time consuming but likely to increase your accountancy fees.

Contact Ashored for more information on incorporation and to determine whether it is right for you and your business.