Choosing between becoming a sole trader or a limited company is one of the hardest decisions you can make as a self-employed individual. This isn’t a choice to make lightly, as it can affect your tax payments, how you withdraw funds, and the legal aspects and paperwork involved. One of the biggest considerations is the risk to your personal assets.
The good news is that neither option is inherently wrong. It depends on your needs and your business’s growth stage. There’s a lot to compare: a sole trader setup is straightforward, affordable, and quick to start, while a limited company offers more tax advantages but also requires more admin.
At Tax Driven Accountants, we’ve worked with both sole traders and limited companies, and we’ve seen how each option can be beneficial.
In this guide, we’ll explain how each structure works, compare expected taxes and outline the advantages and disadvantages of each.
Keep reading to find out more.
What is a sole trader?
A sole trader is the simplest business structure to set up and keep records for. It’s a type of business structure where one person owns and runs the business independently. Essentially, if you’re a sole trader, you and the business are the same legal entity.
What is a limited company?
A limited company is a business structure in which the business and the people who run it are separate entities. The business, directors, and shareholders are legally separate, which provides greater protection for those involved.
Sole Trader vs Limited Company: How They Compare
Before deciding between a limited company and being a sole trader, it’s important to understand how they compare.
Setup
Setting up a limited company and being a sole trader differ in key ways.
Sole trader:
Becoming a sole trader couldn’t be easier. You only need to register for Self Assessment with HMRC once your business earnings exceed £1,000. Setup costs nothing, and your personal details stay private, off public registries.
Limited company:
Setting up a limited company requires you to create a legally distinct entity through Companies House, and you can expect a standard registration fee of £50.
The setup process is relatively fast, and the applications are usually processed within 24 hours. When setting up, you need to select a unique company name which does not match an existing business.
You must appoint at least one Director and at least one Shareholder. These can be the same person, and you must select a registered office address, where the company’s legal mail will be sent.
You must then adopt a Memorandum of Association and Articles of Association, which outline how the company is run. You can find standard templates during online registration.
Once this is sorted, you must submit Articles of Incorporation, which automatically registers the company for Corporation Tax.
You must then open a separate business bank account, ensuring all company finances are entirely separate from your own.
Setting up a limited company can be complex, which is what puts many people off. Rather than avoiding it entirely, we recommend working with an experienced accountant to help with your company formation.
Admin burden
The administrative burden differs significantly between a sole trader and a limited company.
Sole trader:
The administrative burden as a sole trader is minimal. You only need to track business income and expenses and file an annual Self Assessment return with HMRC, along with your quarterly Making Tax Digital reports.
You can withdraw money freely from the business accounts without formal dividends or payroll paperwork.
Limited company:
As the owner of a limited company, you must file annual accounts with Companies House and a separate Corporation Tax return with HMRC.
As a limited company, you must maintain and submit a confirmation statement detailing directors and shareholders, process formal payroll, and declare dividends with proper meeting minutes, so you have more admin to manage than as a sole trader.
Tax treatment
One of the biggest differences between being a sole trader and a limited company is how taxes are treated.
Sole trader:
As a sole trader, you pay Income Tax on your business profits. You pay Income Tax at 20%, 40%, or 45%, depending on profits, plus Class 4 National Insurance: 6% on profits between £12,570 and £50,270, and 2% on any amount above that. This system is straightforward but offers less flexibility.
Limited company:
The company pays Corporation Tax on its profits at 19% for profits up to £50,000, rising to 25% for profits over £250,000, with marginal relief in between. As a director, you can take income through a mix of salary and dividends. Dividends don’t attract National Insurance, which is where many business owners find real tax savings once profits grow, and this is one of the biggest advantages of being a limited company.
Liability
Something to think about is liability as a sole trader and limited company.
Sole trader:
As a sole trader, you have much more liability than a limited company. You and the business are one, so the personal risk is unlimited, with all of your personal assets being at risk if something goes wrong within the business.
If any lawsuits are raised in relation to your business, you are personally sued, so you are entwined with the business.
Limited company:
As a limited company, your business is a separate legal entity and your personal risk is limited to the share and investment value that you have put into the business. If the business falls on hard times, creditors will pursue the company’s assets and sue the company, not you, protecting your personal assets.
Privacy
Another difference between sole traders and limited companies is privacy.
Sole trader:
As a sole trader, your financial records are private and not published publicly. Only HMRC needs to know your business’s financial condition, and it never becomes public knowledge, which is one of the biggest advantages of being a sole trader.
Limited company:
Limited companies require much more transparency, including filing annual reports and accounts with Companies House, which makes financial records accessible to the public. This increased transparency can enhance credibility with customers and suppliers.
Credibility
Credibility is key as a business owner, and it is true that your business may be perceived differently depending on whether you choose to be a limited company or a sole trader.
Sole trader:
Being a sole trader can sometimes be perceived as less professional or credible, especially in certain industries where larger, more formally registered businesses are expected. Whether this matters depends entirely on the industry your business operates in.
Limited company:
Operating as a limited company can boost your credibility with clients and partners, as it shows a formal commitment to the business and provides liability protection.
Cost
Cost is always something that should be considered as a business owner, and there is a big difference in the costs of becoming a sole trader and a limited company.
Sole trader:
Typically, sole traders have lower setup and operating costs, with minimal paperwork and fewer regulatory burdens. You only need to register with HMRC and can often manage finances without extensive accounting services.
Limited company:
Operating as a limited company involves higher costs due to accounting and legal fees, as well as costs associated with company registration and ongoing compliance requirements. These costs can vary from business to business, and if you want more clarity on the costs you may incur as a limited company, getting a free quote from an accountant is the next step.
Making Tax Digital: what changes for sole traders
Although we are still in a transitionary phase, the introduction of Making Tax Digital for Income Tax means the traditional Self Assessment return is set to be replaced in the coming years.
If you want to find out more about Making Tax Digital, we have created a full guide for landlords and sole traders, and you can find out more information here.
At what profit level does a limited company make sense?
If your business is successful and making substantial profits, you will reach a point where it makes sense to transition to a limited company. Once annual profits consistently exceed £30,000 to £45,000, it makes financial sense to become a limited company.
If you are considering transitioning to a limited company and you need support in the process, we’re here to help. It might feel complicated, but with the right support, it doesn’t have to be.
Pick the right formation for your business with Tax Driven Accountants
So there you have it, everything you need to know when choosing between becoming a Ltd company vs a sole trader.
If you’re a new business or a growing company looking for financial support, you’re in the right place. At Tax Driven Accountants, we’ve helped businesses with their business formation, and we’re here to help you.
Get in touch with us to find out how we can make the process easier.
