Sole Trader vs Limited Company: All the Info

Go solo or set up a company? Here’s what you need to know…

Are you thinking of starting a business and want to know the difference between a sole trader and a limited company? We’ve got you covered. 

Here, we dig into the ltd v sole trader debate, sharing the pros, cons, and tax implications of each business structure. 

Ready? Let’s get started. 

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

To understand the difference between sole traders and limited companies, it’s helpful first to define the two business structures.

What is a sole trader?

A sole trader is exactly what it sounds like. It’s a self-employed person who’s the one and only owner of their business. It’s the easiest (and most popular) way to set up a business. 

You can register as a sole trader on the website. You must do this for tax purposes once you start earning over £1,000 a year from self-employment. 

It’s important to note that a sole trader is not legally distinct from their business. So, if the business goes into debt, the sole trader is personally liable.

What is a limited company?

A limited company (ltd company) is another type of business structure. Unlike a sole trader, a limited company has its own distinct legal identity. This is separate from the people that own it (the shareholders) and the people that run it (the directors). 

There’s no minimum number of shareholders required for a limited company. So, in theory, a limited company could be owned and managed by one director who owns 100% of the shares.

Is it better to be a sole trader or a limited company?

So, which business structure should you choose if you’re just starting out? Let’s look at the pros and cons of a sole trader vs limited company.

What are the advantages of becoming a sole trader?

The main advantage of setting up as a sole trader vs a limited company, is that it’s incredibly straightforward. It’s quick and easy to register. And besides filing an annual Self Assessment tax return, there’s very little paperwork involved to run your business. 

Read more: How to Register as Self-Employed in the UK

You’ll also enjoy greater privacy when compared to a limited company. Directors have their details posted on the Companies House website, whereas sole traders do not. (Companies House is the government body responsible for administering company information in the UK.)

Sole trader disadvantages

The downside to registering as a sole trader is limited growth. There’s often a ceiling for how much you can scale your business as an individual, and raising finance to expand can be difficult. Banks and investors tend to favour limited companies, as their investment has more protection.

Do sole traders have limited liability?

No. Sole traders have what’s known as “unlimited liability”. 

That’s because there’s no legal difference between the individual and their business. If the business gets into financial trouble and racks up debts, the business owner is personally liable. This could put their personal assets at risk if things go wrong. 

Limited company advantages

The biggest benefit of setting up a limited company is that it gives you legal protection as the business owner. In other words, you have “limited liability,” and your personal assets aren’t exposed in the event that things go wrong. If the company goes into debt, you’ll only lose what you put into it.

Running a limited company also allows you to build and protect a brand. Once you’ve registered your company name, no one else can use it. And if someone tries, you can take legal action against them.

Sole traders aren’t offered the same protection when it comes to company names. 

Limited company disadvantages

One thing that can put some people off setting up a limited company is the level of responsibility. Company directors have “fiduciary duties,” which they are legally obligated to carry out. These include filing an annual company tax return and producing annual accounts. 

Those extra responsibilities can be time-consuming and expensive. You’ll need to either stay on top of the extra paperwork or hire an accountant to handle it on your behalf. 

Who pays more tax, a sole trader or a limited company?

Asking yourself, “Should I be a sole trader or a limited company in the UK?” Tax will be a key part of your considerations. And how much you’ll pay will depend on how much you earn. 

Sole traders pay income tax and enjoy a tax-free Personal Allowance (currently £12,570). But once you reach a certain earnings threshold, it might make more sense to transition into a limited company setup. 

Limited companies tend to be more tax efficient than sole traders. The company pays corporation tax on their profits, rather than income tax. And the corporation tax rates are, at the moment, lower than the higher rates of income tax. 

Plus, limited companies enjoy a wider range of tax advantages and allowances. That means they can reduce their overall tax liability more effectively than sole traders. 

How much can I pay myself as a sole trader? 

As a sole trader (and owner of your business), you’re entitled to all profits after tax

It’s entirely up to you how much you pay yourself from your business profits. If you have a particularly lucrative month, you could take every penny. But you may want to leave some in your business bank account just in case the next month is a little leaner. 

When it comes to paying yourself as a sole trader, there are a few things you should do:

  • Keep a record of your drawings (the money you take from your business account to pay yourself) and any other income and expenses. Keeping accurate records will make your Self Assessment tax returns far more straightforward.
  • Set aside around 25% of your monthly income for your tax bill. If you’re VAT registered, you’ll need to set aside more than that to cover the quarterly VAT payments. 

Can I have employees as a sole trader? 

Yes, you can, but there are certain responsibilities you’ll need to carry out as an employer. Those  include registering with HMRC and paying your employees’ tax and National Insurance contributions through PAYE (Pay As You Earn). 

We go into more detail on this subject here: Can a Sole Trader Have Employees?

How can I pay myself as a limited company director? 

You have a couple of choices when paying yourself as a limited company director:

  • You can simply draw a salary from the company. As you’re technically an employee of the company, the first £12,570 is tax-free as part of your Personal Allowance.
  • The other option available to company directors is dividend payments. You can take up to £2,000 of dividends completely free of tax. By combining your Personal and Dividend Allowance, you can receive up to £14,570 free of income tax in the 2022/23 tax year.

It’s often a good idea to work with an accountant to calculate the most tax-efficient salary you can take as you grow your business. 

You can find the latest income tax rates and dividend tax rates on the website.

When should I move from sole trader to limited company status?

Usually, the best time to switch from sole trader status to a limited company is when your earnings start to pick up. If you’re consistently hitting the higher income tax rates, it can be more tax efficient to restructure as a limited company.

You may also want to set up a limited company if you’re pursuing business loans or private investment to scale your business. Many banks and investors will only back a limited company (rather than an individual) as it gives their investment more protection.  

Bottom line: sole trader vs limited company 

So, is it better to be self-employed or to set up a limited company? Ultimately, it comes down to how each business structure will affect the way you work and your ambitions for the future. 

  • There’s less paperwork and fewer legal responsibilities when you operate as a sole trader. But once you start earning more, you could end up paying more tax. Plus, with unlimited liability, you’re on the hook for debts should things go wrong. 
  • Meanwhile, setting up as a limited company means more legal and financial responsibilities. But you’ll have greater protection should the company run into trouble. 

If you’re still unsure, the smart move is to speak to a qualified accountant. They can help you understand your current situation and whether a change in structure would help you earn and grow your business more efficiently. 

Also read:
Self-Employed? What Business Insurance Do You Need?
What is Public Liability Insurance?
What is your ERN? Everything You Need to Know