When deciding on whether you should set up as a sole trader or a limited company there are three broad topics you should consider – tax, liability and reputation, and cost. Looking at these three things will help you make the right choice.
Getting it wrong can be costly to your business. This includes easily measured costs, like paying too much tax, but getting the structure of your company wrong can also cost you unnecessary administration time, and it can even cost you customers.
Here are the main points to consider when you are deciding between setting up as a sole trader (or partnership, which is similar), or a limited company.
You have probably heard that there are tax benefits to setting up as a limited company. That is true, but it doesn’t apply to everyone. In fact you might find you pay exactly the same amount of tax regardless of whether you are a sole trader or limited company.
Why is that important? Running your business as a limited company involves more costs and administration time than running it as a sole trader. There are also more rules. If you are not getting the benefit of lower tax you have to consider whether or not it is worth it.
How do you know? A simple test is to ask yourself how much of the profits of the business you need to live on. If you need everything you will most likely pay the same amount of tax regardless of the company structure.
If, on the other hand, the business makes a profit after you take out your salary, you could benefit from a limited company structure. This is because profits are taxed at the corporation tax rate of 12.5 percent as opposed to personal tax rates, which are up to 55 percent when income, PRSI and USC are all taken into account.
Pensions should come into your tax considerations too. In a limited company you get a larger amount of tax relief on pension contributions than you do with personal pensions, and the thresholds are higher.
When is this important? Arguably always but it comes into sharp focus if you are making large contributions to your pension.
If you are not doing this, and you are taking the full profits from the business as your salary, you will probably find it more beneficial to set up as a sole trader.
Liability And Reputation
One of the key differences between a limited company and a sole trader is liability. In most circumstances (exceptions include things like fraud) the directors of a limited company are not liable for the debts of a business whereas a sole trader is.
The reality of this is much more complicated though. For example, most banks require directors to make personal guarantees when offering loans. Liability is therefore a factor, but you have to look at your own business and personal circumstances.
You also have to factor in other things such as risk and reputation. If your business operates in a sector that involves a large amount of risk, a limited company could offer you a level of protection. When it comes to reputation you have to think about whether there are potential clients in the market who will only do business with you if you are a limited company.
Once you have thought about tax, liability and reputation you have to consider cost. The equation is simple: limited companies cost more in terms of both time and money. There are also more rules, and with rules come penalties if you fail to comply.
That means registering as a sole trader is much simpler and more cost effective. You just have to weigh up whether you get enough of the benefits afforded by a limited company to justify the costs involved.