Sole trader vs limited company: which one to choose?

  • 3 min read
  • Last updated 28 Mar 2024

If you’re looking to work for yourself, then you’ll need to choose between being a sole trader vs limited company.

Each has pros and cons, so let’s explore them both and get you on the right path to shine✨

What’s the difference between a sole trader and a limited company?

Let’s pump the brakes here. What is a sole trader? It’s pretty simple actually – it’s the legal term for self-employed people in the UK. 

So what’s a limited company (LTD)? It’s an organisation you set to run your business, which means that you wouldn’t be completely or wholly responsible for it. Your business finances will be completely separate from your personal ones. 

While they’re also taxed differently, which we’ll get into that shortly, you’re also less liable for the finances and debts of a LTD. They’re not your personal finances or debts, phew.

On the flip side, as a sole trader there’s not much of a legal line between you and your business – your business debts become your personal debts. Any assets you own, like your house or your car, also won’t be protected. You’re also responsible for tracking and reporting your income and then filing a Self Assessment tax return to HMRC. Four words: you’re your own boss. It’s recommended that you explore professional indemnity insurance to keep you as protected as possible.

Another difference is that as a sole trader you register through HMRC, while as a LTD you’re registered at Companies House

Sole trader vs limited company: let’s talk tax

We’re not trying to poop the party, but we are your friendly neighbourhood tax know-it-alls, so we’ll bring tax into it every time. 

So with that being said, let’s talk about the different tax implications and how they differ when you’re a sole trader vs a limited company.

Sole trader tax 101(s):

  • You’ll pay Income Tax on what you earn from self-employment minus your allowable expenses

If your expenses aren’t extortionate (or in this case, less than £1,000) or keeping track of receipts isn’t for you, then claiming the tax-free Trading Allowance is the way to go.

And if you want to keep your receipts but prefer storing them online, you can use our AI data-extraction tool to take a picture, and keep it in your account for later use🎉

Limited company tax 101(s):

If you go the LTD route, then first and foremost, you need to decide how to pay yourself. Here are your options:

  • Through a salary: set up a PAYE (Pay As You Earn) scheme for yourself
  • Through dividends: remember that your company also has to pay Corporation Tax for this option
  • Or a combination of both

Whether you go the sole trader route or the LTD route, there are always tax tidbits to consider, so it’s definitely more of a personal decision rather than a one-size-fits-all one. 

What’s the deal with National Insurance?

Well, as it so happens, National Insurance (NI) is one of the taxes that does differs depending on the path you take.

🚨From 6 April 2024 (the 24/25 tax year onwards), Class 2 National Insurance is being scrapped. If you’re under the threshold and pay them voluntarily to qualify for benefits, you’ll still be able to do so.

At the same time, Class 4 is reducing from 9% to 6%.

  • If you run a LTD, you’re more than likely the director, so you’ll need to pay both NI for both yourself as an employee and as an employer (and you’ve got to follow HMRC’s guidance on how to pay it and what to report)

The NI contributions are a lot more for an LTD and sometimes small business owners prefer to pay themselves a smaller salary and supplement the rest with dividends. 

The mysterious tax return process

If you’re a sole trader, good news, you only need to file a Self Assessment tax return once a year.

  • You can do it yourself for free through HMRC (although it can get frustrating, we’re right here with you)
  • Or the easier option would be to use a tax return service like TaxScouts

If you’re not completely sold on getting your tax return sorted and filed for you, we get it. Read our guide on HMRC vs TaxScouts to get the inside scoop on what makes us the obvious choice. 

If you do business through a LTD, then you need to:

  • Prepare annual accounts ✅
  • File an annual Company Tax Return to HMRC ✅
  • File an annual return to Companies House ✅

Other factors to consider

  • Start-up costs: it’s free to register as a sole trader but there’s a small incorporation fee to pay Companies House
  • Privacy: LTD directors have to provide their details to Companies House, which is available to the public
  • Credibility: depending on your clients, this could affect how you choose to proceed (some companies prefer to do business with other LTDs or with VAT-registered sole traders)
  • Bookkeeping: sole trader finances can be easier to track (especially with free tools like ours), while LTDs often need to resort to hiring someone
  • Funding: it’s notoriously difficult to get a business loan as a sole trader, but it can be done!

How to go from sole trader to limited company ♻️

  1. Register your limited company with Companies House
  2. Let HMRC know you’re not a sole trader anymore
  3. Transfer your sole trader business to your LTD (like business assets, although this may not apply to everyone)
  4. Set up a business bank account in your LTD name
  5. Let the relevant people (like stakeholders) know about the change
  6. Register your LTD for Corporation Tax and PAYE

 It’s completely up to you whether you start as sole trader and then set up a limited company down the line, or if you set it up straight away.

If you ever want to make a switch to go from sole trader to limited company, it’s a straightforward process 🙌

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