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When you set up as a freelancer or start your own business, you need to decide the best company structure for you. The choice between setting up as a sole trader or a limited company can be challenging, and it’s a decision that can impact what happens to your business profits, how you pay taxes and even your personal assets. What works for one company might not work for another, so it’s important that you consider the pros and cons of each option and practice due diligence to make an informed decision.
Read on to find out if you should register as a sole trader or limited company.
Sole trader vs. limited company: what’s the difference?
When you’re starting out as a small business owner, it’s important to understand the implications of your company’s legal status.
In the following sections, we’ll cover the options available to UK businesses, as well as what each entails.
What is a sole trader?
As a freelancer, you may feel that you are your business. Registering as a sole trader would turn this feeling into a legal standpoint.
A sole trader is a self-employed individual with full ownership of their business. The business does not have a separate legal identity from that of the owner, so a sole trader accepts full liability for their business.
As a sole trader, you keep all your profits after tax. You do not pay corporation tax or take a salary because your profits are your salary, and you are taxed on them accordingly through self-assessment. Because there is no legal distinction between a sole trader business and the owner, you are responsible if you run into financial difficulties.
You may find it helpful to open a sole trader bank account if this description applies to you, to ensure you can keep track of your business finances separately from your personal accounts. For more information, read our guide to self-employed bank accounts.
What is a limited company?
A limited company is legally distinct from the identity of its owner, so it can have more than one owner (or director). Each owner has limited liability for the business, meaning their personal finances are not implicated if the company struggles financially.
If you register a limited company, you create an independent entity that you work for – even if you founded it.
You do not take the profits as wages as those profits belong to the company. Instead, you may pay yourself a salary, or choose to be paid in dividends, which are paid only if the company makes a profit. Alternatively, you might choose to be paid a split of salary plus dividends.
Should I set up as a sole trader or a limited company?
Both business models involve pros and cons, so let’s examine these in depth with regard to different aspects of your business.
Tax
Your decision about whether to conduct your business as a limited company or sole trader will impact the tax you pay.
Corporation tax
Limited companies are registered with Companies House, which means they are required to pay Corporation Tax. Corporation Tax is paid on profits derived from doing business, investments and gains made on sold assets.
Income tax
Sole traders do not have to pay Corporation Tax, but must pay income tax at the standard rate as well as National Insurance on all profits.
If you’re a freelancer or contractor, you may be affected by off-payroll working rules, also called IR35. It is important to investigate how this may impact you from a tax perspective before setting up your freelancer business.
» MORE: What is IR35?
Earnings
Sole traders retain all their profits after tax, which is paid via your self-assessment tax return. Earnings are therefore entirely dependent on performance.
With a limited company, however, you have the option to take a salary or dividends, or split take-home income between the two. If you take a salary from your limited company, you will need to register the company as a PAYE employer and ensure that income tax and National Insurance contributions are correctly deducted from your salary.
The amount you pay in tax beyond your personal allowance and your tax-free dividend allowance will depend on your tax bracket.
You can find more information about tax on Gov.uk, or you may consider asking a tax adviser or accountant for more personalised advice.
Responsibility
Being a sole trader may entail less admin than setting up as a limited company, but it may also involve greater personal risk, as there is no legal distinction between your assets and those of your company.
If you run up debts as a sole trader, creditors may have the right to claim your personal assets to balance their books.
Because the owner of a limited company has limited liability, they may not be held accountable for the company’s debts. And, while a sole trader could become bankrupt should their enterprise fail, the owner of a limited company will usually not, as their assets may be protected if the company goes into liquidation.
However, limited liability does not protect you against acting irresponsibly and, as a director, you have specific legal obligations to your company. If you do not comply with these obligations and then your company goes into liquidation, you could still be held personally liable for its debts.
» MORE: Can my personal finances be affected by business insolvency?
Winding up
It is also worth considering how long you expect your business to continue. If you stop trading as a sole trader, then fewer actions are necessary. You must inform HM Revenue & Customs (HMRC) that you are stopping, and send a final tax return.
Winding up a limited company, however, has to be completed in a specific way depending on whether the company is solvent or insolvent at the time. Among other things, you will need to inform HMRC that you’ve stopped being an employer (if applicable), submit a final Company Tax Return and pay any corporation tax that is due. More information can be found on Gov.uk.
» MORE: How is being self-employed different to being a sole trader?
How to register your business
When it comes to declaring your small business’s legal status, you can take different routes, depending on whether you wish to classify as a sole trader or as a limited company.
Registering as a sole trader
Setting up a sole trader business is straightforward. You need to register for a self-assessment tax return with HMRC, after which you need to wait up to 15 days for your Unique Taxpayer Reference (UTR). You should therefore set up your business well in advance of when you are required to submit your tax return.
Registering as a limited company
To set up a limited company, you will need to register with Companies House.
You will be able to register for Corporation Tax when you register with Companies House. But if you have only registered your company, you must register for corporation tax within three months of when you started trading. Then you will need to begin filing your Company Tax Returns each year.
If you register as a limited company then you will be required to have a business name, and will need to register a company name with Companies House.
Setting up a business, whether as a sole trader or as a limited company can be tricky and time-consuming, so you may wish to seek advice from an accountant or financial adviser.
Sole trader pros and cons
Pros
- Simplicity: With no legal distinction between yourself and your business, operating as a sole trader can be a way to keep complexity to a minimum. For example, there is less paperwork and you get to keep any profits!
- Control: Sole traders have full control over their business.
- Privacy: While some information about limited companies will be published by Companies House and be part of the public domain, sole traders have relative privacy.
- Tax benefits: While limited companies are often seen as more tax efficient, businesses with small profits might be better off as sole traders.
Cons
- Liability: Sole traders are fully liable for any losses or debts incurred by their business.
- Professionalism: Clients may consider a limited company to be a more impressive and reliable business partner.
- Funding options: It can be harder to access funding, with lenders often favouring limited companies and other business structures.
Limited company pros and cons
Pros
- Tax benefits: It may be more tax efficient to run your business as a limited company, as the corporation tax paid on profits is lower than the income tax paid by sole traders. You can also choose to take income as a salary, dividends or a mix of the two.
- Limited liability: As a limited company is a separate legal entity from its owners, you will not generally be held personally liable for debts. This can protect your personal finances.
- Easier funding: Limited companies might find it easier to secure business loans than sole traders, while you can also raise money by selling shares in the business to investors.
Cons
- Complexity: Running a limited company will mean more paperwork, as you will have to produce a confirmation statement, accounts and a company tax return.
- Legal obligations: Limited company directors must fulfil certain legal obligations, such as maintaining accurate company records, or they could face fines, prosecution or disqualification from being a director.
Do your research
The sole trader vs limited company discussion is complex and important to consider for any new business owner. The pros and cons can be difficult to weigh up, so consult friends and colleagues who have gone through the process and make sure that you conduct thorough research. Just remember, what was right for one business might not be right for you, so crunch the numbers – and do consider seeking professional advice.
Sole trader vs limited company – frequently asked questions
Sole traders can choose to become a limited company, but there are a number of steps to this process. You will need to form your new limited company, ensure you have a business bank account and transfer your business (including any assets) to the limited company.
You will also need to inform HMRC of the change, de-register as self-employed and register for corporation tax and PAYE. Needless to say, this can be a complicated process and you may need the help of an accountant to manage certain aspects of the transition. As such, it is probably preferable to pick the right business structure from the word go.
You can also switch from being a limited company to a sole trader.
If you are a sole trader, any profits made by the business after tax are automatically yours because you and the business are one legal entity. As such, you can pay yourself whatever wage you like, as the funds already belong to you.
However, it pays to make sure your business has enough money to operate and navigate any bumps in the road, or save some money for reinvestment and growth. You might also want to pay yourself the same amount on the same day each month to help keep on top of your business’s finances.
A separate sole trader business bank account and good accounting software might be the best way to make your life easier in this regard.
Traditionally, limited companies are thought of as more tax efficient. Sole trader businesses with profits of below £1,000 can take advantage of the trading allowance, and will not face any income tax. This remains true if annual profits remain below the threshold of the personal allowance (£12,570 in 2024/25).
However, depending on your business’s circumstances, and whether you have other sources of income, this may not be true.
On the other hand, limited companies pay corporation tax on all profits. For businesses with large profits, being a limited company can be a more tax efficient structure, but newer and smaller businesses may benefit more from operating as a sole trader.
» MORE: How to change a business account from sole trader to limited company
Dive even deeper
How to Set Up as a Sole Trader
by Kristina Fox
Sole Trader vs. Self-Employed: What’s the Difference?
by Jeff Salway