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

Sole trader vs limited company at a glance

Here's how the two compare on the things that matter most.

• Setting up: a sole trader registers with HMRC for free. A company registers with Companies House, which costs £100 online.
• Liability: a sole trader is personally responsible for all business debts. Company owners usually only risk what they've put in.
• Tax: a sole trader pays Income Tax and Class 4 National Insurance on profits. A company pays Corporation Tax, then you pay tax on the salary and dividends you take out.
• Admin: a sole trader files one Self Assessment return a year. A company files accounts, a confirmation statement and a Company Tax Return, and usually runs payroll.
• Privacy: sole traders aren't on a public register. Company directors' names, month and year of birth and a correspondence address are public.
• Running costs: sole traders can often manage with simple software. Companies usually pay more for an accountant.

Liability: what happens if things go wrong

As a sole trader, there's no legal line between you and the business. If the business owes money it can't pay, the people it owes can come after your personal savings and assets. GOV.UK calls this unlimited liability.

A limited company is legally separate from its owners, so shareholders are usually only responsible for its debts up to what they've invested. That protection has limits in practice. Banks and landlords often ask directors of small companies for a personal guarantee, and directors who don't meet their legal duties can face fines, prosecution or disqualification.

For many low-risk service businesses, the right insurance does more to protect you than the structure does. If your work carries bigger risks, such as large contracts, expensive stock or staff, the separation a company gives you counts for more.

How sole traders and limited companies are taxed

Sole traders pay Income Tax on profits above their Personal Allowance of £12,570, at 20%, 40% and 45% in England, Wales and Northern Ireland. Scotland has its own bands. On top of that is Class 4 National Insurance: 6% on profits between £12,570 and £50,270, and 2% above that. It's all reported on one Self Assessment return. The side hustle tax calculator gives a rough estimate.

A company pays Corporation Tax on its profits: 19% on profits up to £50,000 and 25% over £250,000, with marginal relief in between. The money then belongs to the company. To take it out, you usually pay yourself a salary through payroll, which is taxed like any job, and dividends from the profit left after Corporation Tax. Dividends above the £500 allowance are taxed at 10.75% in the basic rate band, 35.75% in the higher rate band and 39.35% above that.

The big difference is control over timing. In a company you decide how much to take out and when, and profit you leave in the business has only paid Corporation Tax so far. As a sole trader, all your profit is taxed in the year you make it, whether you spend it or not.

A simple example of the tax difference

Say you're already a basic rate taxpayer and your business makes an extra £10,000 of profit. This is deliberately simplified. It assumes your allowances are already used and the whole amount stays in the basic rate band. Here's how that £10,000 works out each way.

• As a sole trader: 20% Income Tax (£2,000) plus 6% Class 4 National Insurance (£600) is £2,600, leaving you £7,400.
• Through a company, taking it all as a dividend: 19% Corporation Tax (£1,900) leaves £8,100. Dividend tax at 10.75% on that is about £871, so you keep about £7,229.
• Through a company, leaving it in the business: you pay £1,900 Corporation Tax for now and £8,100 stays in the company. You'd pay dividend tax later, when you take it out.

Is a limited company more tax efficient?

Not automatically. In the example above, the sole trader keeps slightly more if everything is taken out, and the company only pulls ahead on money left in the business. Real life is more complicated. Your salary level, employer National Insurance, pension contributions, the dividend allowance, other income and the extra running costs all change the answer.

That's why we don't give a single profit figure where a company becomes worth it. An accountant can model your actual numbers both ways, and that's worth doing before you switch.

Admin and running costs

Sole trader admin is mostly keeping records and filing one tax return a year, plus quarterly updates if Making Tax Digital applies to you. Registering is free and many people file their own return.

A company has more to do. Every year it must file accounts with Companies House, a confirmation statement (£50 online) and a Company Tax Return with HMRC. If you pay yourself a salary, you'll run payroll and report to HMRC each time you're paid. You may also need your own Self Assessment return to report dividends. Directors stay legally responsible for all of this, even if an accountant does the work.

Most company owners pay an accountant, and fees are usually higher than for a sole trader. Count that cost against any tax saving you're shown.

Privacy: what goes on the public record

When you set up a company, some of your details go on the Companies House register, which anyone can search for free. For directors and people with significant control, that's your name, nationality, month and year of birth, and a service address for post. Your home address and full date of birth are kept off the public register. If you use your home as the company's registered office address, though, that address will be public. The company's filed accounts are public too.

Sole traders don't appear on a public register like this. If privacy matters to you, that's a point in favour of staying a sole trader, or of using a separate service address and registered office if you do form a company.

Credibility, and when people usually switch

Some larger clients, agencies and public sector buyers prefer or insist on working with limited companies, partly for their own tax and employment status reasons. For most customers it makes little difference. People booking a dog walker or buying from a local baker rarely check, and a clear website, sensible terms and good reviews matter more than 'Ltd' after your name.

Plenty of people start as a sole trader, test the idea, then move to a limited company later. Common reasons are profits moving well into the higher rate band, wanting to leave money in the business to reinvest, taking on bigger contracts or more risk, bringing in a co-founder or investor, or a client asking for it.

Switching means setting up a company, moving the business into it and telling HMRC you've stopped trading as a sole trader. There can be tax points to watch, for example with equipment or the value of the business, so get advice first. If you want to think through your own situation before that conversation, Exitnine Coach can help you work out the questions to ask. If you're starting now, our guide to registering as self-employed covers the sole trader route.