Sole Trader or Limited Company: Which Suits You?

Deciding between operating as a sole trader or limited company is a crucial decision for any self employed business owner.

Both sole traders and limited companies have their own benefits and drawbacks which must be carefully considered when making a decision that will affect business operations, taxes and personal finances.

In our sole tradership or Ltd company guide we explore the key differences between sole traders and limited companies including their legal structures and implications on income tax.

We highlight the advantages and disadvantages of each option to help you make an informed decision based on your individual and business needs.

By understanding these critical aspects of both sole trader and limited company structures you’ll be better equipped to choose the most suitable path for your small business venture.

Sole Trader vs Private Limited Company: What are the big differences?

The key differences between a sole trader and a limited company are focused on legal structure and taxation.

Potentially paying less income tax is a common reason for choosing a limited company structure but it’s not the only factor worth knowing more about.

Typically the three main differences are:

Legal structure: Sole traders operate as individuals with no legal distinction between their business and personal assets; private limited companies have separate legal entities.

Taxation: Sole traders pay income tax on profits; private limited companies pay corporation tax on profits.

Limited liability: Private limited companies offer shareholders protection against debts; sole traders are personally liable for all business debts.

Sole Trader or Limited Company Legal Structure

It’s essential to understand the main legal differences and characteristics between these two business forms.

Understanding the legal part is important so you can put plans in place to protect yourself and your business from a legal perspective.

Sole Trader legal:

A sole trader is an individual who runs their own business and is solely responsible for its debts and liabilities.

As a sole trader you are self employed and not considered an employee of your business.

This means that you have full control over your business but also bear all financial and legal risks associated with it.

Limited Company Legal:

A limited company is a separate legal entity from its owners (shareholders) and directors. It has its own rights and responsibilities under UK law – including paying corporation tax on profits earned by the company rather than personal income tax like sole traders do.

A limited company owners’ personal assets are typically safeguarded from any liabilities or debts incurred by the business which limits their losses to just what they have invested and no more.

Sole Trader vs Limited Company Taxation

Tax is probably the most common deciding factor when it comes to choosing between operating as a sole trader or a limited company.

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Both options have different tax requirements and potential benefits that can significantly impact your overall financial situation.

Sole Traders Taxation:

As a sole trader you are responsible for paying income tax on your profits through the self assessment system.

There are three gradually increasing rates at which tax is payable on sole trader income which are 20%, 40% and 45%.

Income tax is not payable on total income below the tax free personal allowance which is £12,570.

Sole traders can claim various expenses against income which reduces taxable profit and income tax due.

HMRC need you to declare your sole trader income and expenses on a self assessment tax return.

Sole trader key tax facts:

• Income tax: Sole traders pay income tax at their personal rates which range from 20% to 45% depending on their total income.
• National insurance: Class 2 NICs are paid at a flat rate per week while Class 4 NICs are calculated as a percentage of annual profits above certain thresholds.
• VAT registration: If your turnover exceeds the VAT threshold (£85,000 as of 2023) you must register for VAT and charge it on applicable sales and submit VAT returns.
• Sole trader registration: To register as a sole trader you should notify HMRC within three months of starting your trade.
• Making tax digital: From 6 April 2026 sole traders with income of £50,000 or more will need to report under the making tax digital regime which means reporting income and expenses more often along with keeping records digitally.

Limited Company Taxation:

When operating as a limited company you’re business will be subject to corporation tax instead of income tax.

Additionally if you take money out of the company in dividends or salary form (rather than reinvesting them into the business itself) there may be further taxes applied such as dividend tax or income tax under PAYE.

HMRC will normally need a limited company to file an annual return detailing the companies corporation tax liability.

Limited companies must submit annual accounts to companies house which include details about profit margins, dividends paid out to shareholders along with any relevant financial statements such as balance sheets or cash flow forecasts.

Limited company key tax facts:

• Corporation tax: Limited companies with a profits under £50,000 pay corporation tax at a flat rate of 19% on their profits, which is generally lower than the Income Tax rates paid by sole traders. Companies with profits over £50,000 will pay more than 19% corporation tax up to a maximum of 25%.
• Dividend tax: If you take money out of your company as dividends you’ll need to pay dividend tax based on your personal income tax bands. However there’s an annual dividend allowance that allows for some tax free dividend income.
• PAYE and NICs: If you draw a salary from your limited company it will be subject to pay as you earn (PAYE) taxes and class 1 national insurance contributions. Your company will also have to make employer’s NICs contributions on salaries above certain thresholds.
• Company director tax: A company director will need to submit an individual self assessment tax return and pay income tax on qualifying PAYE and dividend income.

What are the advantages and disadvantages of a Sole Trader?

Advantages of a Sole Trader:

• Simplicity: As a sole trader, you’ll find that setting up your business is relatively straightforward. There are fewer legal requirements compared to forming a limited company.
• Fewer reporting requirements: Sole traders have less stringent reporting obligations than limited companies, which can save time and effort in managing your business finances.
• Total control: Operating as a sole trader means you retain complete control over your business decisions without having to consult shareholders or directors.
• Tax efficiency for smaller incomes: If your income is below the higher tax threshold, being a sole trader may be more tax efficient due to lower overall taxation rates.

Disadvantages of Sole Trading:

• Limited liability protection: Unlike limited companies, sole traders do not benefit from liability protection. This means that if your business encounters financial difficulties or legal issues, your personal assets could be at risk.
• Potential tax disadvantages for higher incomes: If you earn above the higher tax threshold as a self employed individual (over £50k), operating as a limited company might offer better tax efficiency through dividend payments instead of salary.

What are the advantages and disadvantages of a Limited Company?

Advantages of Limited Companies:

• Limited liability protection: One of the main advantages of operating as a limited company is the protection it offers. Your personal assets are separate from your business, meaning you’re not normally personally liable for any debts or legal issues.
• Tax efficiency for higher incomes: As mentioned earlier, limited companies can be more tax efficient for those earning above the higher tax threshold due to dividend payments and lower corporation tax rates.
• Professional image: Operating as a limited company may provide a more professional image to clients and customers compared to being self employed.

Disadvantages of Limited Companies:

• Incorporation process: The process of setting up a limited company involves additional paperwork and costs compared to sole trading.
• Filing requirements: Limited companies have stricter reporting requirements than sole traders, which could lead to increased administration work in managing your finances.

What is better: Sole Trader or Limited Company?

Making the best decision for your business depends on your individual needs, preferences and circumstances.

When deciding between being a sole trader or a limited company you should think about all the factors that are important to you right now like financial liability and tax efficiency but don’t forget more longer term issues like the administrative burden, business image and future growth.

Financial liability:

If limiting your personal financial liability is important, then forming a limited company may be the better option for you.

As a sole trader you are personally responsible for any debts incurred by your business whereas in a limited company the responsibility lies with the company itself.

Tax efficiency:

Tax efficiency plays an important role in choosing between being a sole trader or operating under a limited company structure.

Limited companies typically have more opportunities for tax planning and can benefit from lower corporation tax rates compared to income tax rates faced by sole traders.

Administrative burden and accountancy costs:

Sole traders generally face less administrative burden than limited companies because they don’t need to file annual accounts or adhere to strict reporting requirements imposed on companies by companies house and HMRC.

If simplicity is what you’re after operating as a sole trader might suit your needs better but always remember an accountant can take on the workload for you.

Your accountancy bill will normally be higher when running a limited company because of the extra work involved to meet HMRC and companies house requirements.

Business image:

For some businesses and industries having the image of being incorporated as a limited company can enhance credibility and professionalism in the eyes of clients or customers.

The distinction between a sole trader and a limited company may not be as significant for others so doesn’t warrant any consideration for example if your working as a freelancer or in a creative field.

Future growth:

Future growth or selling your business is not necessarily on your agenda for now but this might change especially if a competitor makes you a lucrative offer to buy you out!

Expanding the size of your business or taking on employees in the future can be made easier when operating as a limited company.

If finding external investment or selling your business is part of your long term strategy being incorporated may be more attractive to potential investors or buyers.

What’s the difference between the accounts of a Sole Trader and a Limited Company?

Sole traders maintain simple financial records including profit/loss statements while limited companies must prepare annual statutory accounts that comply with UK accounting standards (UK GAAP), submit them to companies house, file corporation tax returns, maintain share capital records, directors’ reports and other mandatory filings.

Your accountants bill will usually be higher with a limited company because there’s often more work involved for an accountant in comparison to a sole tradership set up.

Have you thought about a Partnership?

A partnership is another option to think through. It’s not for everyone but is worth mentioning so you can compare it to the sole trader and limited company structures.

Our partnership tax guide will let you know more about how a partnership business structure works so you can compare it with your other options.

Can a small business accountant help me decide?

Making the decision on how to set up your business in the best way can be challenging with information from the internet often all you are left with.

A small business accountant can make sense of the bits you don’t fully understand and lay out a strategy based on your businesses future plans.

Talking it through with an accountant as part of the process can bring you clarity which is particularly important before making any decisions based on potential tax savings alone.

Your accountant can explain in depth how operating as a sole trader may be simpler and have lower start up costs but forming a limited company can provide benefits in the future such as limited liability, tax planning opportunities and easier expansion.

Always remember…

Being open minded to change in the future can help keep your business moving in the way you want it to.

Some businesses start out as a sole tradership and then decide to change to a limited company simply because things have changed and incorporation makes more sense.