What is the right structure for your business?
Choosing your business structure and identifying the accompanying legal requirements is absolutely essential; as this will affect how you run your business, how you will do business in the future, and perhaps most importantly, the taxes you pay.
No matter what home-based business you are planning, it could be a beauty salon, pet sitting service, language tutor, physical therapist, landscape gardener, affiliate seller, or eBay seller. Before you take another step, you need to decide what type of legal structure will be best suited for your business.
The 3 most common types of business structure
While there are several different types of business structures, there are only three main types to explore when operating a home-based business: Sole Trader, Partnership, or Private Limited Partnership.* Below is a breakdown of each type of business structure. , along with their pros and cons, what you have to do to set them up, and finally what the likely costs will be.
*There are others such as Public Limited Companies, Unlimited Private Companies and Companies with the Right to Manage, but there is no need to worry about them. If your business takes off and your empire expands, just get your lawyers to sort it out.
1. Sole Trader
Setting up as a sole trade is by far the simplest and most straightforward way to start a business. You can get started at any time by simply registering your business and there is no fee! The good news is that after taxes, any profit goes directly into your pocket. The bad news is that if your business fails, you are personally liable for any debt, which means your home and any other assets can be repossessed.
The advantages:
- Quick start-up with no registration fee
- Minimal records and accounting.
- Greater flexibility as you can control when and where you work
- Increased privacy by not having to answer to anyone else
- Any after-tax profit is yours and yours alone
The disadvantages:
- You are personally responsible for any debt
- You are solely responsible for all legal requirements and paperwork involved in submitting your annual tax bill and paying your own National Insurance Contributions (NIC).
- Insurance premiums like life, home and auto are generally higher
How to become a sole trader
All you need to do is register with HM Revenue & Customs (HMRC), which you can do online by going to HMRC. You will be asked for basic information about you and your business, HMRC will be happy to establish tax records for you and you. they are ready to go! Once registered, you’ll receive a self-assessment tax return to complete each tax year (April 6-April 5) and the friendly folks at HMRC will calculate how much you owe. NB: Even if you already complete an annual tax return, you must inform HMRC as soon as possible or you may be fined!
Records you must keep
- General accounting of expenses and income of all costs related to the business
- If you are employing people, you must hire them as a supplier and keep a note of the costs or, if you employ them full time, calculate their monthly income tax and NIC with Pay As You Earn (PAYE)
what it will cost you
- Income tax on any earnings
- National Insurance Class 2 at a fixed rate
- National Insurance Class 4 on any benefit
- PAY if you are employing people
2.Association
If you don’t want to go it alone, a business partnership is the next natural progression. In essence, a partnership consists of two or more self-employed workers who work together and share the workload and resulting profits. While it is not a legal requirement to have a formal agreement, I highly recommend it! Like any relationship, it all starts with good intentions and a shared vision, but things go wrong, circumstances change, and it can all too easily end in tears. I once established a partnership with two of my best friends and everything went perfectly for almost three years until cracks began to appear. The result was a lengthy court battle to ‘divorce’ us from our partnership, resulting in two fewer names on my Christmas card list.
The advantages:
- Quick start-up with no registration fee
- A formal agreement is not required (although it is recommended)
- Minimal records and accounting.
- Someone to brainstorm and share the workload with
- Shared cost and risk
- Any after-tax profit is shared between the partners
The disadvantages:
- With a simple partnership, you are not only responsible for the debts of the partnership as a whole, but also for debts incurred by other partners. regardless of whether you agreed to the expense or not.
- Profits are generally shared in equal proportions, regardless of the actual work contribution made
- You are jointly responsible for all legal requirements and paperwork involved in filing your annual tax bill and paying your own National Insurance.
- Insurance premiums such as life, home, and auto are generally higher.
How to form a company
Each the partner must individually register with HM Revenue & Customs (HMRC) (even if any of the partners already complete an annual tax return, they should all inform them as soon as possible or they may be fined!) Optional: a partnership deed describing how the business and duties and responsibilities of each partner will be managed. You don’t have to go to a lawyer to draw up a partnership, just draw up and sign a mutually agreed division of profits and most importantly, what happens in case of breakup of society.
Records you must keep
- One partner must be designated as the designated officer, responsible for filing the partnership’s annual tax return.
- General accounting of expenses and income of all costs related to the business increased by each partner
- A partnership statement showing how the profits (or losses) have been divided between the partners
- In most cases, each partner is responsible for paying their individual Income Tax or Social Security Contributions based on the above.
- If you are employing people, you must hire them as a provider and keep a note of the costs or, if you employ them full time, calculate PAYE.
What it will cost each partner
- Income tax on any prorated earnings
- National Insurance Class 2 at a fixed rate
- National Insurance Class 4 on any apportioned utility
- PAYE if the company is employing people
2b. limited liability company
The main difference between an LLP and a standard partnership is that the business is responsible for the debts of the business and not the individual partners. This protects partners from personal bankruptcy and debts incurred by other partners, but offers exactly the same tax advantages as a normal partnership. All the other details for forming and running an LLP are as above, except that the accounts will likely need to be audited and filed with Companies House.
3. Private Limited Liability Company
If you really want to protect yourself from any potential business failure, then it may be wise to choose a Private Limited Liability Company. The company is owned by its shareholders, but it is a completely separate legal entity and the company structure limits shareholder liability to the value of the shares issued. Which basically means that if the business goes bankrupt, your personal assets can’t be touched (unless you’ve been acting illegally…). There is no minimum share capital requirement, but the shares cannot be offered to the public and any profit is paid to shareholders in the form of a dividend.
The advantages:
- Keeps business and personal finances completely separate
- If the business goes bankrupt, you don’t
- Generally considered a safer business trading partner than a sole trader or partnership
The disadvantages:
- Lots of paperwork and lots more rules.
Before you can start trading, you need a certificate of incorporation issued by the Registrar of Companies. While Companies House will automatically pass on your HMRC details, you should also contact your local HMRC office to let them know of your company’s existence.
Records you must keep
- Your company name, place of registration, registration number, and registered office address should be clearly displayed on everything from your letterheads to invoices, websites, and emails.
- Detailed accounting of all business related expenses
- All payments to salaried directors, employees and contracted services
- Self-assessment of the corporate tax level to be paid
what it will cost
- Corporate tax on all profits
- PAY to collect monthly Income Tax and Social Security Contributions of all employees and directors
Value Added Tax (VAT)
Finally, whatever business structure you choose, by law you must register for VAT if your business is going to make more than the current figure of £77,000 a year. If you really don’t think your business will exceed this number, then you can wait, but keep a close eye on your monthly numbers! HM Customs and Excise have more power than the police and can enter your home at any time, without a warrant, and 16 anything they think is related to their investigation. I remember being given two hours’ notice of a visit by an inappropriately named Mr Pratt from the VAT office, who proceeded to audit my returns with astonishing insight. As a result, when he left my office, he, or rather HMRC, was several thousand pounds richer.
Moral: don’t mess with the VAT office!