Q&A Friday - How should I structure my small business?

One of the most important decisions you will make when starting your business or when considering the legal structure of your existing business is: What is the best structure for my business? Your decision will impact the amount of tax you pay, the control you have on your business profit and how you plan to pay yourself a salary from your business.  So it is very important to take the time to consider the best option for you: Sole trader or limited company? Partnership or LLP?

We look at the pros and cons to help guide you on this very importance decision.Some business structures are more complicated to manage than others. Let's look at thee sole trader structure first.

The pros and cons of registering as a sole trader

As a start-up with limited resources of cash, this may be the option for you.  Sole traders are often considered 'one man bands'.  Despite the name, as a sole trader you can hire staff, but being careful to follow the rules around employing staff as a sole trader.  More often than not though, sole traders do not tend to hire staff.The main thing here to note is that as a sole trader, any decisions you take for the business will be instant and you can move quickly where perhaps larger competitors cannot and you gain the market advantage.In terms of your profit and tax liability, everything related to the business, including profit and assets, belongs to you personally, after you have paid tax.

Sole trader advantages:

1. Low barriers to entry - you can start trading immediately with very little red tape. Once you have informed HMRC you are self employed, you are on your way!

2. Which means you can order your business cards straight away and start marketing yourself.

3. All your profits and assets in your business are yours, after paying tax

When starting out, you may find the sole trader structure is right for you, especially when you start to do well and you can enjoy tax deductible expenses such as business travel, working from home expenses and any other business related expenses, which are all deducted from your taxable income, and in turn reduce your tax liability.In terms of compliance reporting to the taxman too, you only need to complete a tax return annually.

Sole trader disadvantages:

1. Your business income is taxed at a higher rate than limited company structure. As a self-employed individual, you will be subject to income tax versus corporation tax, and could end up paying more tax dependent on your annual turnover. This is not always the case, so it is worth speaking to us to find out what structure works best for your business.

2. Unlike limited company structure, you have no limited liability, which means that the distinction between business and owner does not exist. This means that if your business fails, your personal wealth could be affected too.

3. A sole trader business does not automatically continue after your death, as it does as a limited company structure, which is a standalone entity.

When a business starts to grow and turnover starts to exceed £30,000 - £40,0000 and more, and you start to pay more income tax and move away from the basic rate income tax bands, this is a good time to start thinking about a limited company structure.Your tax bills will likely increase which in turn puts even greater risk of your overall wealth.

So what legal structure is best for me?

See the table below for easy comparison of the different legal structures you can choose for your business:

Type Structure For Against Sole trader Exclusive owner of the business, entitled to keep all profits but liable for all losses

• Low cost, easy to set-up

• Full control retained

• Very little financial reporting

• Full liability for debt

• Pay more in tax

• Lacks credibility in market

Partnership Between two or more individuals who share management and profits

• The above, but with more heads

• More potential to raise finance

• The above, affecting all partners

• Can be messy to wind up

Limited company Private company whose owners are legally responsible for its debts only to the extent of the amount of capital they invested

• Less personal financial exposure

• Favourable tax regime

• Ability to work for corporate clients

• Administrative and regulatory demands heavier

• Annual accounts and financial reports must be placed in public domain

Limited liability partnership (LLP) Some or all partners have limited liabilities, and exhibits elements of partnerships and corporations

• Flexibility: can be incorporated in members' agreement

• Advantages of limited company and partnership combined

• Profit taxed as income

• Partners must disclose income

• LLP must start to trade within a year of registration – or be struck off

What is a partnership?

Partnerships are very similar to a sole trader model but there is more than one of you managing the business.  For example a husband and wife team building a business together.  The partnership structure is just as flexible as a sole trader, but has the added benefit of two heads are better than one!Things to look out for in a partnership that you wouldn't necessarily experience as a sole trader include considerations of split of profit and ownership of the business and formalising this for both parties sake.  This is critically important if you experience any bumps in the road if/when you want to wind up the business sometime in the future.  You can usually formalise your business arrangement by a Partnership Agreement.In a standard partnership, as with sole traders, all partners are also responsible for all the debts owed by the business. This doesn't only apply to debts you have incurred as a partner but to those of any partner, so you need to pay particular care to the conduct of the people you go into business with.In addition, if your profits are over £5,885 you will have to pay Class 2 National Insurance contributions (NIC) at a rate of £2.75 per week; you can apply for an exception if your net earnings are below this.If your profits are over £41,865 your will also start paying 9% of your profits between £5,885 and £41,865.

Is Limited Company structure right for me?

Incorporating means registering a limited company or LLP at Companies House and moving away from sole trader or partnership structure.There are lots of reasons why you may want to move to limited company structure, not withstanding the tax and accounting implications.  Being incorporated for example may give your business greater credibility when going out and marketing to clients.  Indeed, some clients may insist you are incorporated so they have the comfort that you are business that is established and is lower risk than a sole trader structure.Look carefully at your motives to being a limited company director: there is increased responsibility as a director of a company, including more compliance reporting to HMRC and Companies House and higher accounting costs.Clearly the greatest advantage of being a limited company is limiting your liability to the business, so your personal and business assets are separate. If your business should run into any financial trouble, for example, your personal assets will not be affected.  As a Director of a limited company, you are an employee of the limited company, which is a standalone legal structure.When it comes to tax, the tax system is more favourable to limited companies versus sole traders.  Limited companies pay corporation tax on profits of the business at a flat rate of 19% as at today's date.  As a Director of a limited company, you will however to pay income tax if you take a salary from the limited company, or alternatively you can extract profit from the business via tax efficient dividends.