When you first start a freelance business, there is one important choice you have to make right at the very start. Do you strike out alone as a sole trader or do you form a limited company? There are plenty of implications of making that choice, and we’re going to go through all of them with you today.
So, if you are considering taking the leap to becoming a freelancer, read on. We’ll explain whether a sole trader is your best shot, or, of you should dive in straight away as a limited company. Let’s kick things off with some of the basics.
Define your situation
The truth is there is no answer to this all-important question without understanding your own situation. Just as every individual and business are different, so are you as a freelancer. It is vital, however, to make a decision as soon as possible.
Due to the tax implications, you could end up wasting a lot of money if you choose the wrong direction. There could be legal issues, too, depending on which way you turn. You’ll also need to take into account your future plans.
How much money will you be earning? Will you scale your business quickly or do you intend to spend a few years working things out? And, if you go down the route of being a sole trader, are you prepared to accept how other businesses might see you?
The legal aspects
Becoming a sole trader is easy. All you need to do is sign up with HMRC, keep proper accounts, and pay your taxes and National Insurance on time. When you are a limited company, things are a little different. There are a lot more rules and regulations in your way so you can expect to be paying a lot more fees for lawyers, accountants, and services.
For example, once you register at companies house, you need to file your official business address. It’s not just a ‘nice to have’, either. As https://www.yourcompanyformations.co.uk/address/registered-office/ point out, it’s a legal requirement. You could use your home address, or that of your parents, or another family member. You can also use third party companies who will provide you with a forwarding service.
That said, becoming a limited company does give you a lot of protection. Your personal assets are protected against your business’s debts and risks. Let’s say you work in something like IT security and make a severe mistake, as a sole trader you might end up as personally liable. As a limited company owner, however, your personal property – your house or car, for example – are perfectly safe.
The difference in taxation for sole traders and limited companies will have a big impact on your choice. As a sole trader, you pay 20% tax on your profits above the £11,000 personal allowance threshold.
You will then pay 40% on earnings in the next band up, above £32,000. Then, you will pay 45% on your profits above £150,000. However, when you earn over £100,000, you lose all your personal allowances, which, effectively, means a tax rate of 60%. Don’t forget, you also pay Class 4 and Class 2 National Insurance contributions. Class 2 payments are at most £2.80 per week. Class 4 contributions will cost you 9% on profits between £8,060 to £43,000, with a further 1% on your further profits.
According to http://www.contractoruk.com/calculators/, with a limited company, things are a little different. You pay 20% corporation tax – which will be reduced to 19% in 2017 and 17% in 2020. You won’t pay NICs on your company profits – only what you pay yourself as a salary. And, your taxes with a salary will be the same as a sole trader. But here’s the thing – you can pay yourself in dividends, rather than a salary. Which means you could pay yourself a tax-free salary up to your personal allowance, and then 7.5% on dividends over £5,000 from April 2017. Earn over £32,000, and you’ll pay 32,5%, or over £150,000, it’s 38.1%.
It sounds complicated, but the key issue for freelancers making their big decision is this. If you earn as little as £20,000 a year, you can save £500 on taxes and National Insurance. You’ll have to take into account the extra fees you will pay for accountancy, of course. But the more you profit as a sole trader, the more you will lose to tax and NICs, which could be saved by making the switch.
As you can see, you don’t have to earn a lot before becoming a limited company is worth it. If you intend to get off to a good start, form a limited company – it’s as simple as that.