When you change from working as a sole trader to running a limited company, you’ll need to think about how your business might change and the various things you’ll need to be aware of. If you’re not sure what business structure is right for you, we’ve written an article to help.
If you think you’re ready to change from a sole trader to a limited company structure, here’s a simple explanation of when to make the transition and what you’ll need to keep in mind, without all the jargon.
When is the right time to form a limited company?
Typically, people start contracting or freelancing as a sole trader for the ease of set-up and potentially lower administrative burden when compared to setting up a limited company.
After increasing their earnings, though, many sole traders then consider setting up a limited company to pay less tax and increase their attractiveness to potential clients. The time may also be right to involve others in your business as directors and shareholders.
The common consensus is that when your earnings remain low, it may be best to remain as a sole trader, unless you need other benefits such as limited liability. As a sole trader, your tax and accounting responsibilities will be relatively simple - maybe even simple enough to do it yourself if you’re really organised.
When your earnings start to pick up, it becomes more economical to move to a limited company format and save yourself money on tax. Our Take-Home Pay Calculator can show you how much this might be. It updates depending on your company profits and the tax rates in place each year. Our simple rule of thumb is that the tax savings outweigh the costs of running a limited company once your sole trader profits reach around £30,000 per year.
What are the benefits of setting up a limited company?
We’ve actually written a whole article about sole trader vs limited company vs umbrella which goes into all the details. But, in short, as well as potential tax savings, there’s also: limited liability, greater borrowing power, improved reputation and credibility.
You need to set up a separate bank account
One of the benefits of running a limited company is that you won’t be personally responsible if your company makes any losses or has a claim made against it, which means all of your business finances must be in the business name.
Limited companies need to have separate accounts in the company name as the money belongs to the company and not the director. You need to set up a separate business bank account in the name of your limited company. It’s highly recommended you don’t use the personal bank account you may have used when you were a sole trader for your company’s finances, or you could incur some nasty tax consequences.
As a limited company, you’re taxed personally on the money you take from the business in salary and dividends. Any other money you take would be treated as a director’s loan, with specific HMRC rules you need to follow. As a sole trader, all of your profit is taxable to you personally.
Income is processed differently
Your personal income from your limited company will be paid to you in a combination of a director salary, which is an allowable business expense, and dividends. Dividends are taken from the profits of your company after paying Corporation Tax and are paid to you because you’re a director and shareholder in the company. We have a separate article on how much salary you should take from your limited company and why it can be more tax-efficient to take a lower salary.
Since your tax will be calculated differently, you’ll need to keep your personal and business financial affairs (including bank accounts) completely separate.
You’ll have different taxes to report and pay.
As a sole trader, you’ll have been submitting your annual Self Assessment to HMRC and they’ll have calculated what Income Tax and self-employed National Insurance you needed to pay. As a limited company director, you’ll still need to file an annual Self Assessment tax return, but you’ll also need to file a regular payroll (usually monthly) for any salary you take.
As mentioned above, you may not need to pay Income Tax or National Insurance on the salary, depending on how much you decide to take. But you will need to declare any dividends you receive from your limited company (and any other sources of income you may have.
As a limited company director you’ll need to file various tax returns and accounts to HMRC and Companies House. You’ll also need to pay your company's Corporation Tax Bill. We’ve got separate articles on Small Business taxes and your responsibilities as a company director.
Business expenses are treated differently
You can claim tax relief on a variety of business-related expenses as a limited company that you couldn’t as a sole trader.
Our article on limited company business expenses will help you understand what you can and can’t claim for - or if you'd like to download our guide to read at your leisure, click the banner below.
Who should be a director
Usually, if you’re setting up a limited company for your business then you’ll also be a director. It’s not too difficult, but there are things you’ll need to be aware of as a director. But what about if you’re working with a business partner, or you want your spouse or partner to be a director and shareholder?
These can be difficult decisions with potentially costly implications if you get them wrong, so we’d recommend getting some professional advice. We offer a free consultation where our accountants and advisors can talk you through your options, so why not give us a call on 0333 311 8000?
Transferring your assets to your limited company
If you bought any business assets when you were working as a sole trader, you’ll be able to transfer them to your limited company when you incorporate. However, there might be tax implications of doing this, therefore it is vital you speak with an accountant for bespoke advice.
When you’re self-employed (as a sole trader) you pay tax on your income via your annual Self Assessment. Depending on your earnings, you may have to pay Income Tax at the highest rate (45%) and National Insurance as well.
When you’re a limited company, though, the main rate of Corporation Tax (in the 2021/22 tax year) is 19%, meaning your business tax bill could be much smaller. Don’t forget you’ll still pay personal tax on any salary or dividends taken from your limited company via your Self Assessment. However, with careful planning, you can minimise the amount of tax you pay. Try our Take Home Pay Calculator or speak to one of our advisors.
IR35 is tax legislation that is designed to combat tax avoidance by workers supplying their services to clients via an intermediary, such as a limited company, but who would be an employee if the intermediary was not used. Such workers are called 'disguised employees' by Her Majesty's Revenue and Customs (HMRC).
The reason this legislation exists is that HMRC is concerned that some businesses are using their limited companies solely to pay less tax.
You’ll need to know whether any contract you take on as a limited company is subject to IR35 rules or not. HMRC are strict on this and can impose taxes and penalties if you get it wrong. We have an IR35 Hub that will help you understand what your responsibilities are and how to make sure that you’re IR35 compliant. We even have a free IR35 Calculator that can show you whether any of your assignments may be at risk of being inside IR35.
What to tell HMRC
You need to notify HMRC that you are now working as a director and that you aren’t working as a sole trader anymore, as your tax payments will change.
We can take care of getting your new limited company set up and registering you for all the correct taxes if you become a Crunch limited company accounting client. Even if you’re not a Crunch client, you can still use our Crunch formations service to set up your limited company in just a few minutes.
The importance of a good accounting set-up
What this all emphasises is the key role that your accountant plays in ensuring a limited company set-up is best for you. Traditionally, one of the aspects of a limited company that puts people off people is the perceived hassle that setting up and running one creates.
However, with advances in technology, there’s no longer an excuse for the administration of your limited company to be overly time-consuming.
For example, online technology can be used to enable automatic invoice processing, automatic VAT calculations (should you decide to be VAT registered) and expenses management.
It seems only natural that freelancers and contractors working online are able to maintain and check their business accounts via the cloud. Almost all accountants now use cloud technologies and Artificial Intelligence to look after their clients’ affairs.
HMRC also recognises the importance of technology through its Making Tax Digital (MTD) strategy for the online filing of tax information for businesses and individuals.
Without the right technology in place, running a limited company can be an unwelcome burden for freelancers and contractors.
The ideal accountancy model to support your limited company
The ideal model to provide the accountancy support your limited company needs is an all-in-one accounting solution that enables you to manage everything online with handy apps, while having access to expert accountants as and when you need them.
Some accountants offer these services, but make sure you check the small-print. Some online products are advertised as being supported by accountants, without actually providing you with access to the advice you need. It simply means that accountants can update your online software with your income and expenses if you give them your passwords.
Another area to consider is the costs your accountant will charge you. These vary greatly and whilst some accountants promise low rates, it’s the hidden costs and added extras that can soon stack up.
For example, if you phone your accountant for advice, will they charge you for contacting them? Are there any extra charges for essential tasks such as sending information to HMRC and Companies House? Do they charge you for basic personal and company tax advice?
Because of the wide range of pricing models in the industry, many small business owners are put off from forming their own limited company. Why form a limited company if there’s no guarantee of getting the level of service you need at a cost you can afford?
It’s a real shame if people are missing out on the benefits of running their own limited company because they can’t find the right accountancy solution.
However, owning a limited company isn’t just about saving money – it’s also an issue of financial security and the ability to separate the financial health of your business from your personal finances. It’s for these reasons that Crunch was formed in the first place: by combining online technology with real accountants on the end of a phone and email, accounting should be a breeze.
Get an accountant!
Well, we would say this, wouldn't we! Getting an accountant is a great way to keep on top of your finances. They’ll remind you of important tax deadlines and payments due, show you ways of keeping your accounts in excellent shape, and advise you on allowable expenses and how to report them so you’re as tax efficient as possible.
They can help you with things like estimating how much tax and NI you’ll need to pay every six months - or quarterly for VAT. They’ll also help to ensure you’re not forgetting any payment on account, which catches many people out every year.