Sole trader or limited company: which one to choose?
If you’re looking to work for yourself, then you need to choose between becoming a sole trader or setting up a limited company.
Each has pros and cons.
- you’ll pay Income Tax on what you earn from self-employment minus some allowable expenses
- if your expenses are not that high or you can’t be bothered with receipts, then claiming the flat £1,000 “trading allowance” is much easier.
If you go the limited company route, then you need to decide how to pay yourself:
- through a salary: you need to set up a Pay As You Earn (PAYE) scheme for yourself
- through dividends: remember that before paying dividends your company also has to pay 19% corporation tax
- or a combination of both.
Winner: limited company, but not by much – mostly because you have more freedom in how you pay yourself and what you can expense.
This is one of the biggest differences.
- If you’re a sole trader, then you only pay Class 2 and Class 4 NI contributions
- If you run a limited company, you will pay much more: both the employer’s and employee’s National Insurance on your director salary.
This is why most one-man-band limited company directors prefer to pay themselves only enough salary to qualify for State Pension, and the rest as dividends.
Winner: sole trader.
The tax return process
Sole traders only need to file a Self Assessment tax return once a year:
- you can try doing it yourself for free
- or use a tax return service like TaxScouts for just £119.
If you do business through a limited company, then you need to:
- prepare annual accounts and a company tax return, which you file with HMRC
- and also file a confirmation statement with Companies House.
Corporation tax returns are much more expensive and you’ll also need to deal with bookkeeping or hire an accountant to do it for you.
Winner: sole trader – by far.
Debts and legal risks
This is another huge difference:
- If you’re a sole trader, you are your business. Any business debts become your debts and what you own (including your house!) is not protected. However, a good professional indemnity insurance should be sufficient for most sole trades.
- A limited company can protect you: the loans belong to the company, not you.
Winner: limited company – but only if you need business insurance or a business loan.
Other factors to consider
- start-up costs: it’s free to register as a sole trader with HMRC (although it’s a bit complicated: TaxScouts can help you register as self-employed for just £25)
- privacy: limited company directors have to provide their details to Companies House – this info will be public
- credibility: many companies prefer to do business with other limited companies, or at least with VAT-registered sole traders
- funding: it’s very difficult to get a business loan as a sole trader.
Switching from one to the other
You can easily do it.
We recommend to start small as a sole trader and, if your business grows, set up a limited company later on.
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