Sole trader vs limited company: A complete guide

If you’re thinking about entering the world of self-employment, you might be wondering whether to work as a sole trader or set up your own limited company. It’s totally understandable if you’re not one hundred percent sure about what these two things are though – the world of business jargon is tricky at the best of times, let alone if you’re new to self-employment.

In this guide, we explain:

  • what it means to be a sole trader
  • what it means to set up a limited company
  • the main differences between sole trader vs limited company
  • some pros and cons of being a sole trader vs limited company

Before we get started, it’s useful to know that the structure you choose for your business will affect things like:

  • How you pay tax, and how much you might end up paying
  • How easy it is to access the money made by your business (how you pay yourself)
  • How much paperwork you have to do each year
  • How much privacy you have as a business owner
  • What happens if someone decides to sue your business, or your business gets into debt
  • How easy it is to get investments for your business

Long read alert!

We noticed that a lot of content online only really skims over the basics of what it means to be a sole trader vs limited company. So we wanted to create a guide that offers more detailed information.

In the UK, the options you have when it comes to choosing a legal structure for your business are:

  • Sole trader – you’re the only owner of your business, which is not a separate legal entity from you. You’re liable personally for the business.
  • Limited company – where your company is a separate legal entity to you, personally. 
  • Partnership – like being a sole trader, but there are two of you who have shared responsibility for the business. 
  • Limited liability partnership – like a partnership but with the ‘limited liability’ of a limited company.

What’s a sole trader?

A sole trader is a self-employed person who is the one and only owner of their business. Being a sole trader is the simplest business structure there is. 

(By the way, you can still give your sole trader business a unique name – it doesn’t have to be your own name.)

You can be a sole trader in basically any industry – you might be a freelance photographer, run a plumbing business with employees, or work as a self-employed hairdresser. You can employ others as a sole trader, too.

Being a sole trader can be less tax-efficient than running a limited company 

This is because limited companies have a set corporation tax rate of 19%, while tax rates can go up to 40% for any income a sole trader makes over £50,271, with an additional rate of 45% for anything earned over £150,000. (Tax rates are slightly different in Scotland.)

Limited companies also don’t pay any National Insurance on dividend payments (that’s chunks of their company’s profit they can pay themselves – more on tha below). All this sounds like sole traders are getting a way worse deal – but in reality there are lots of cases where the costs of running a limited company outweigh any small amount of savings made on tax. 

Being a sole trader is still the more popular form of business legal structure in the UK – in fact, 80% of people who make the majority of their income from self-employment are sole traders. This number is even higher when you include people with side hustles. 

It’s simpler to operate as a sole trader than a limited company

There’s less paperwork to do each year, and you can immediately access your business’s profits without going through certain processes first. (You can read about these processes in the section on limited companies below.)

You’re personally liable for your business as a sole trader

When you’re a sole trader, you are your business – it’s not treated as a separate entity. That means you’re personally liable if the business gets into debt, or is sued by someone. Say, for example, you were a freelance graphic designer and made a mistake that cost your client a lot of money. If they decided to sue you, your own personal money or property could end up getting seized to cover the costs. 

Of course, there’s business insurance to protect you in scenarios like this. Specifically, professional indemnity insurance covers you if a client decides to sue you because of a mistake in your work.

Setting up as a sole trader is easy

It’s really easy to set up as a sole trader and there’s not a lot of paperwork to do each year. You just have to file a Self Assessment (tax return), which is where you declare things like how much money you’ve earned and how much you’ve spent on business expenses. 

To set up as a sole trader, you need to register for Self Assessment on the .Gov site

You pay tax as a sole trader through an annual tax return (Self Assessment)

When you’re a sole trader you have to pay Income Tax if you earn more than £12,570 in a year (that’s your tax-free Personal Allowance). And you have to pay National Insurance on any profits over £6,515 (National Insurance rates vary depending on how much you earn).  These numbers include any income you make from all lines of work. 

Say, for example, you’re employed part-time, earning £15,000 a year from this work, and also earned £2,000 in a year from a side hustle. You’d need to pay tax and National Insurance on £4,430 (that’s £15,000 + £2000 minus the £12,570 Personal Allowance). 

Rates vary between 20% and 45% for Income Tax, and 2% and 9% for NI, depending on how much you earn.

You can read about filing a Self Assessment and paying your tax bill here. And you can read about the key tax dates for sole traders here.

You can use your own personal bank account as a sole trader, or set up a business one

This is up to you. If you want to keep your sole trader finances separate, you can set up a business bank account. Or if you feel that’s too much faff, you can get paid directly into your personal account. 

(Tip: Finmo lets you easily tag your live bank transactions as ‘business’ or ‘personal’ making it super-easy to sort your income and expenses – even if you use your personal account for your sole trader work.)

What’s a limited company?

A limited company is its own legal entity. It’s separate to its owner or owners. When you set up a limited company, you ‘serve’ it as a director. You can be the only owner or there can be more than one owner. 

You’re not personally liable for the business with a limited company

When you set up a limited company, the business becomes its own separate entity. This means that your personal property and finances are kept separate from the company’s. So if the company gets into debt or is sued, you only stand to lose what you’ve put into the company – not your own personal property or money. But – it’s common for banks and lenders to ask for something called a ‘personal guarantee’. That basically means that if your business fails, they can come after your personal assets to collect on their loan. 

There are different types of business insurance to protect companies against scenarios like this, though.

Getting paid when you own a limited company

With a limited company, the profits you make don’t just go automatically into your bank account. The two ways you can get ‘paid’ are:

  • Through a salary: you can be an employee of your limited company and take a salary, just like if someone else employed you. To do this you have to register your limited company as an employer. You’ll have to pay Income Tax and National Insurance on your salary, just like if you were employed by someone else. You’ll also have to pay Employer’s National Insurance as the owner of a limited company that employs other people (even if the only person it employs is you.)  
  • Through dividend payments: Dividend payments are payments you and other shareholders of the company can give yourself out of the company’s profits. To do this, you legally have to have a director’s meeting to agree on the amount of the payment/s– and you’ll need to keep a record of the minutes of the meeting. This still applies even if you’re the only director of the company – there still needs to be minutes shown of the decision to take a dividend payment.

You can then produce a dividend voucher, which is essentially the payment. You can do this as often as you want, as long as there are enough profits in the company.

Setting up a limited company (and privacy implications)

All limited companies have to be registered with Companies House. That means details about your business – like its name, trading address and current and resigned officers – are published online for everyone to see.

There’s more paperwork and responsibility involved with being a limited company

Directors of limited companies have the added responsibility of acting in line with certain laws called the ‘Director’s Fiduciary Responsibilities’, which include things like ‘a duty to act in the best interests of the company’. There’s also more paperwork to do each year, as you need to file:

  • Annual accounts – to report the financial performance of your company
  • A confirmation statement – providing general information about your company (there’s a fee to pay each year for this)
  • A corporation tax return – that’s how your company pays tax (this is separate from your own personal Self Assessment, which is the form you fill out to declare how much you’ve personally earned, and how much tax you owe)
  • If you’re VAT registered – VAT returns to show how much value added tax (VAT) your company should pay (you don’t have to be VAT registered though, and it’s also worth noting that sole traders can be VAT registered if they want) 
  • Employer PAYE returns – if you employ yourself or anyone else
  • Event-based filings to Companies House – to keep Companies House updated with any changes to your company, like a change of address

Paying tax as a limited company 

Limited companies pay ‘Corporation Tax’ on their profits (after allowable business expenses have been taken off). The Corporation Tax rate for limited companies in the UK is currently 19%. 

Limited companies don’t pay Income Tax or National Insurance, but any salary you or another shareholder takes from the company will be subject to these two things (depending on how much the person earns in total in a year). And don’t forget – limited companies have to pay Employer’s National Insurance if they pay anyone a salary.

Any dividends you or another shareholder takes is only subject to Income Tax, not National Insurance. This is one of the reasons it can be more tax efficient to own a limited company than be a sole trader. 

You might be able to claim a wider range of business expenses as a limited company 

For example, you can claim for costs associated with entertaining clients, which you can’t do as a sole trader.

A limited company has its own bank account

A limited company has to have its own business bank account (you can’t just use your own personal bank account). This is a legal requirement to keep your personal finances separate from the businesses – because the business is a separate legal entity to you.

Sole trader vs limited company comparison table

There’s a lot to get your head around when it comes to fully understanding the different nuances of being a sole trader vs a limited company. To help make things a little clearer, we’ve drawn up a brief comparison table to show some of these key differences. 

Sole Trader Limited Company
You’re personally liable for the business (including if it gets sued or gets into debt). The business is its own separate legal entity, which you’re not personally liable for (your own personal finances are kept separate if the company’s sued or gets into debt).
You have to set up as a sole trader (if you earn more than £1k per year from sole trader work) by registering for Self Assessment. You have to register your company with Companies House.
You don’t have to publish any information about your business anywhere. People can see information about your business online (on Companies House).
You can get your clients to pay you into your own personal bank account, or you open a separate business bank account for your sole trader finances. A limited company has to have its own separate business bank account – you have to pay yourself a salary and/or take dividend payments from your limited company to access its profits.
You don’t need to go through any official procedures to access the money you make as a sole trader. You have to set your limited company up as an employer if you want to take a salary from it. And you’ll need to host an official director’s meeting to take any dividend payments.
The Director’s Fiduciary Responsibilities that apply to limited company owners don’t apply to sole traders. You have certain additional legal responsibilities as a limited company director called the Director’s Fiduciary Responsibilities.
You just have to file one document a year – a Self Assessment. There are quite a few different documents to file each year.
You pay Income Tax and National Insurance on your sole trader earnings (rates vary between 20% and 45% for Income Tax, and 2% and 9% for NI, depending on how much you earn). Limited Companies pay Corporation Tax (set at 19%). You pay Income Tax and National Insurance (NI) on any salary you take from the company. You only pay Income Tax (not NI) on dividend payments.
The annual cost of a high street accountant is about £300-600. (Finmo is designed for sole traders and costs between £142 – £238 a year, which includes ongoing accountancy support and tax return reviews.) The annual cost of a high street accountant is about £750-2000.

Pros and cons of sole trader vs limited company

Below, we’ve summarised a few of the main pros and cons of being a sole trader vs limited company. 

Sole trader advantages

  • Easy to set up
  • Less paperwork 
  • Less legal responsibility 
  • Greater privacy as a business
  • Easier to access profits as and when you want
  • No need for a separate business bank account (but you can have one if you want)

Sole trader disadvantages

  • You’re personally liable for the business 
  • Raising finance can be trickier as banks and investors are more likely to invest in limited companies
  • In some cases, it can be less tax efficient to be a sole trader

Limited company advantages

  • You’re not personally liable for the business, so you personal finances/assets aren’t exposed
  • It can be easier to secure investments and expand as a business
  • Tax rates can be kinder for limited companies
  • Once you’ve registered your company name, no one else can use it

Limited company disadvantages

  • It can feel more complicated and time-consuming to run a limited company vs being a sole trader
  • There’s quite a bit more annual paperwork involved
  • It’s a bit more complicated to access your company’s profits
  • Greater legal responsibility 
  • Less privacy as a business

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