Sole trader vs limited company: which is right for you?

If you are starting a business or your profits are growing, you have probably asked yourself:

Should I stay a sole trader or set up a limited company?

It is one of the most common questions we hear from freelancers, consultants and small business owners across the UK.

This is not a question with a straightforward answer, and it certainly is not the same for every business.  It depends on your profits, your plans and how you want to run your business.

Let’s break down the real differences between a sole trader and a limited company, without the jargon.

What is a sole trader?

Being a sole trader is the simplest way to run a business in the UK.  You register as self-employed with HM Revenue & Customs, submit a tax return each year and pay tax on your profits.  Legally, you and the business are the same thing. There is no separation.

Why the sole trader structure can be simple.

Most businesses begin this way because it is straightforward. There is less admin and less paperwork.  Your accounts are not public and you are in full control.

If you are just getting going or testing an idea, this is usually the best way to do that.

The downside of being a sole trader

The important thing to understand is liability.  If the business gets into debt, you are personally responsible. There isn’t a legal barrier between your business finances and your personal finances.

For some businesses, that risk is small. For others, especially where contracts or borrowing are involved, it’s something to take seriously.

How does tax work for a sole trader?

As a sole trader, you pay:

– Income Tax on your profits
– National Insurance on your profits

For the current tax year:

You don’t pay tax on the first £12,570. After that:

– 20% tax up to £50,270
– 40% tax above £50,270

You also pay National Insurance at:

– 6% between £12,570 and £50,270
– 2% above £50,270

This is all calculated through your Self Assessment tax return.

When does being a sole trader become less tax-efficient?

At around £30,000 profit, remaining a sole trader is often perfectly sensible. The tax difference between a sole trader and a limited company can be relatively small once you factor in extra accountancy costs.

Once profits start approaching £50,000 to £60,000 and beyond, higher rate tax comes into play. This is usually when we are asked whether it is time to switch to a limited company.

What is a limited company?

A limited company is legally separate from you.  It is registered with Companies House and has its own legal identity.  When it is incorporated, it is issued with its own birth certificate, and the status of the company has to be updated each year with Companies House.

The company earns the income. You then pay yourself from the company, usually through a combination of salary and dividends.

Why do people choose a limited company?

The biggest advantage is limited liability. In most cases, your personal assets are protected if the company runs into financial trouble.

There can also be tax planning advantages once profits grow. Dividends are taxed differently from salary, and this can create a tax saving compared to paying higher rate Income Tax as a sole trader.

Operating as a limited company can also feel more established. Some clients and lenders prefer dealing with companies rather than individuals.

The trade-off

Running a limited company involves more responsibility.  You must file annual accounts and confirmation statements and there are fines if the deadlines are missed.  Your financial information appears on the public record.  While we can restrict how much is on public record, there have been discussions in government about forcing companies to report more details publicly.  However, this legislation is currently parked.

You have legal duties as a director. There is usually more accountancy work involved because a limited company is a bigger beast.

The compliance is more structured.

What is the tax difference between a sole trader and a limited company?

This is usually the key question.

A limited company pays corporation tax on its profits. For smaller companies, this starts at 19%, increasing as profits rise over £50,000.  After corporation tax is paid, you take money out as dividends. Dividends are taxed at different rates than salary, which is where the potential tax efficiency comes in.

However, the difference isn’t always dramatic at lower profit levels. Once you factor in accountancy fees and admin time, the savings may be modest.

At higher profit levels, the gap tends to widen.  That’s why there is no fixed “magic number” where everyone should switch to a limited company.

It depends on your circumstances.

Sole trader or limited company in the UK: what should you consider?

Tax is important, but it should not be the only factor.

We also look at:

– The level of financial risk in your business
– Whether you plan to grow, employ staff or bring in investors
– How stable your profits are
– Whether you might sell the business in future
– Your long-term personal income goals

The right structure should support where you are heading, not just save a bit of tax this year.

So which one is right for you?

If your profits are steady at around £30,000 and your business risk is low, staying a sole trader may be completely appropriate.

If profits are rising towards £60,000 or more, or you want additional protection, it may be time to explore setting up a limited company.

But this is not a decision to make based on generic advice online.  Your business is unique. Your goals are personal. And your structure should reflect that.

If you are unsure whether to stay a sole trader or switch to a limited company, we can run the numbers properly and talk through the bigger picture with you.