Sole traders are companies that are registered to the individual that founded them – the company is exclusively owned by the individual, who is entitled to keep all profits after tax. The individual and the company are legally indistinguishable, meaning that the individual is personally liable for any of the mistakes the company makes. As someone who is running their own business, sole traders are listed as self-employed.
Sole traders need to pay income tax and national insurance on their profits by submitting a self-assessment tax return to the associated governmental department – in the UK, this is the HMRC. It is the responsibility of the sole trader to ensure that all the information is accurate and up to date, and the individual may face legal or financial consequences if there are any errors in their reporting.
As a sole trader, calculating the profits is straightforward – simply subtract the business’s allowable expenses from the total income. This results in the profits before tax. The specific tax rates for income tax and national insurance will depend on the individual’s circumstances and the current tax regulations, though income tax rates typically increase as income levels rise too.
Once the tax rates have been confirmed subtract the income tax and national insurance contributions from the business’s profits before tax to determine the net profit.
Limited companies, on the other hand, can be owned by one or multiple people, also known as shareholders. The ownership is directly correlated with proportional ownership, and the business is registered as a separate legal entity (unlike sole traders, where there is no legal distinction between the trader and the company).
Calculating the profits before tax is basically the same method that sole traders use – establish the business’s overall expenses and subtract that from the total revenue.
Once this is done, limited companies need to calculate their corporation tax – at the moment in the UK, that rate lies at 25%. Apply this rate to the company’s taxable profits (which are the profits after deducting expenses and other governmental allowances) to establish the net profits after tax.
Being a limited company has associations of legitimacy and authenticity, which can make a business more attractive than being a sole trader in certain industries. As shareholders are separate legal entities, this naturally relieves them of financial and legal liability for the company’s operations. However, being a limited company may require you to adhere to even more legal obligations and could involve external intervention from governmental agencies.
ABOUT COUNTING KING
Counting King is a national tax and funding practice that helps companies with their cash flow by sourcing grants, utilising government tax incentives or finance options such as business loans and more to help them scale and grow!
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