This article is for informational purposes only and is not intended to be legal or tax advice regarding business formation. If you’re starting a business, consult with your lawyer or accountant before deciding on a structure.
Entrepreneurs have many decisions to make when they start a business. But none may have more of an impact than deciding on a legal structure for your business, also referred to as declaring a business entity.
That’s because the form of business you choose helps to determine the income tax return form you have to file. So your decision affects your taxes, your earnings, and, ultimately, your business’s bottom line.
What is a business entity?
A business entity is another name for the type of business structure a venture sets up. The type of structure has legal, tax, overall ownership and operational implications.
Types of business entities overviews
Here are some of the most common types of business structures you may file for when you’re starting a business.
A sole trader owns a business alone and is personally liable for the company’s debts and obligations.
There are several reasons why being a sole trader is appealing to new business owners. A sole trader is in complete control of the business and has total authority to make decisions. This control, of course, comes with several disadvantages as well. Because the business belongs solely to the owner, it’s all the more important to have accurate books and records to clearly delineate one’s business from one’s personal assets. This also means that any financial decision made for the business also affects the owner’s personal finances.
Tax responsibilities for entities taxed as a sole trader
A sole trader pays income taxes by completing a self-assesment tax return every year. You’ll also need to:
- Keep records of sales and expenses.
- Pay income tax, plus Class 2 and Class 4 National Insurance.
- Pay VAT if your turnover is more than £85,000.
Naming your business as a sole trader
When you start as a sole trader, you can trade under your name or another name, and you don’t need to register. You must include your name and any business name on your official paperwork. When deciding on a name, bear in mind sole traders can not:
- include ‘limited’, ‘ltd’, ‘LLP’, ‘public limited company’ or ‘PLC’
- use an existing trademark
- be offensive
But there are still other steps to take. You might create a business bank account to help you better separate your business and personal finances.
General business partnership
A general business partnership is a business entity in which two or more people agree to share all assets, profits, and liabilities of the business. Unless agreed otherwise, all general partners may contract on behalf of the partnership business, meaning that a single general partner can bind the partnership and other partners to a contract with a third party. This means trust is a key component in the success of a general partnership business structure.
Forming a general partnership can be advantageous because you and your partner(s) can quickly make decisions and create a lean business model. General partnerships are also generally inexpensive. Unless you are hiring a lawyer to review a formal partnership agreement (which isn’t required but may be a good idea), there is little cost to start this type of business.
The informal nature of a general partnership can have drawbacks as well. Because there are no limitations on liability, all partners share the liability for issues that arise and the personal finances of all partners can be affected.
Tax responsibilities for entities taxed as a general business partnership
Generally, you and your partner(s) share responsibility for the business, including:
- any losses
- bills for stock or equipment
Each partner usually pays tax on their share. Bear in mind a partner doesn’t have to be an actual person - a limited company can count as a legal person and be a partner.
Starting a general business partnership
To start a business as a general partnership, you have to choose a business name, choose a nominated partner and register with HM Revenue & Customs (HMRC). The nominated partner takes responsibility for the partnership’s tax returns and records.
Limited liability partnership (LLP)
A limited liability partnership (LLP) is a type of business entity that has two or more partners. A member can be either a person or company (corporate member).
Tax responsibilities for entities taxed as a partnership
Every member pays tax on their profit share, but is not personally liable for any debts the business is unable to pay.
Starting an LLP
Starting a limited partnership can take more time than a general partnership because of the necessary documentation. You need to draft a partnership agreement with legal assistance in order to standardise terms of the business and lay out liability. The cost of a limited partnership depends on the complexity of the partnership agreement and liability structure between the partners.
You’ll also need to register with Companies House, and there are more complex rules on naming your company.
A limited company is privately managed, run by directors and owned by shareholders. The company is a separate and distinct legal entity, which means it is responsible for everything it does and finances are separate to the owners’ personal affairs.
Tax responsibilities for entities formed as a limited company
Generated profits are kept by the company after paying Corporation Tax. Then, profits are distributed to shareholders as dividends.
Starting a limited company
Before starting a limited company:
- Choose a name.
- Pick your directors
- Choose a company secretary
- Decide on the shareholders or guarantors
- Identify people you will give significant control (PSC) to
- Make documents that agree on how to run your company
- Check what type of records you must keep
- Register your limited company