Sole Trader or Limited Company? What’s Right?

Trying to decide whether sole trader or Limited Company is right for you? It’s a tough choice because the right answer depends on what you think will happen with your business in the future and none of us has a crystal ball.

In this guide, you’ll find the main differences between the two business structures including the tax benefits as well as how to download a sole trader or LTD calculator to check which minimises your tax bill.

There’s no jargon, I promise! But there is quite a lot of information, so you may want to bookmark this page so you can come back to it as you work through each stage of setting up your business.

Updated 8 November 2021

Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.

1. Sole Trader or Limited Company?

Ask anyone who knows about becoming self-employed, they will no doubt have an opinion on the sole trader v Limited Company debate. Even accountants will give conflicting advice! But even if you are new to self-employment you’ve probably heard that when you run a business choosing the right business structure will help to:

  • Maximise your take-home pay and;
  • Minimise your tax bill.

If you have more than one source of income or a non-standard tax code, you should probably contact an accountant for advice.

1.1 What is a Sole Trader?

A sole trader is a person who works for themselves as an incorporated business. Unlike a Limited Company, sole trader businesses are not legally separate entities. Registering as self-employed (or sole trader) is the quickest way to start a new business but even though all the money you make belongs to you but you are personally liable for all the debts and being a sole trader can quickly become less tax efficient. Despite these drawbacks, being self-employed means:

1.2 What is a Limited Company?

A Limited Company is a popular business structure. An LTD is a separate business entity from yourself, responsible for all the business’ liabilities and owns all the trade and profits.

If you set up a Limited Company you will be the Director. It will be your responsibility to run the Company to the best of your abilities and elect to pay dividends to its shareholders. Limited Companies are registered at Companies House, which is the government body that:

  • Holds a register (or list) of UK Limited Companies;
  • Sets out the rules Limited Companies need to follow in terms of reporting and disclosures;
  • Fines Limited Companies who do not stick to the rules;
  • Discloses certain information about Limited Companies like who the shareholders and directors are and certain financial information;
  • Ensures every Limited Company that is formed has a unique name.

To pay yourself from a Limited Company you’ll have to buy shares in the Company, set yourself up as a Director and pay yourself a salary/dividends to extract money. For that reason, it is better to always enlist the help of an accountant if you plan to form a Limited Company so that you know you:

  • Are paying yourself tax-efficiently;
  • Are not taking more money out of your LTD making dividends illegal;
  • Are filing all the right statutory accounts and returns with Companies House and HMRC;
  • Are not disclosing too much information about yourself in the public domain such as your home address.

If you are planning to set up a Limited Company, then using an accountant is definitely advisable because they will help you to file your accounts, manage taxes and help you pay yourself in the most tax-efficient way. However, this will come with a cost and at the very least, the tax-saving from choosing Limited Company over sole trader should offset your accountants’ bill.

2. Sole Trader vs Limited Company Tax Calculator

This sole trader v. Limited Company tax calculator (updated for the 2021/2022 tax year) will help you to estimate which business structure will help you to decide which will generate the bigger tax saving. Just input your expected business profits and it will be automatically worked out.

Enter your email address below to receive a copy of the sole trader or Limited Company tax calculator:

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3. Tips on Choosing Between Sole Trader or LTD

When it comes to deciding whether it is best to become a sole trader or Limited Company it’s important to be realistic about how much money they think they really will earn. Starting a business is exciting but it can take time to build up your income. In your first year, you’ll be busy setting up your business and finding clients, meaning you may not be at full earning capacity. Setting up a start-up budget will help with your financial predictions and decision making as well as:

  1. Taking advantage of the £1,000 trading allowance while you get your business up and running;
  2. Registering as self-employed as your business grows and you surpass the trading allowance rules;
  3. Incorporating and LTD when the time is right, you feel ready to deal with the administration and have sufficient profits to pay for an accountant.

Remember any tax savings need to outweigh accounting fees you’ll need to pay to take care of administration and structure your earnings tax efficiently. Having a Limited Company means you’ll need to prepare full accounts, including a balance sheet. Whereas being a sole trader means you need to fill in a tax return with just your income and expenses once a year, which many do themselves rather than hiring an accountant.

4. Future Proofing Your Business

Going from sole trader to Limited Company is something many decide to do when the time is right. As part of future-proofing your business, check the name you want is available at Companies House, just like you would a domain. If it is available, then you can form your Limited Company and keep it as a dormant company – that way you’ll only need to deal with very minimal filing requirements but have your LTD name ready for when you need it.

Related:

Taxes are changing! From April 2024 sole traders will need to report their earnings and pay tax on a quarterly basis. This is known as Making Tax Digital, which you can read more about in this guide to help you get prepared.

About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek, money nerd and creator of www.goselfemployed.co - the UK small business finance blog for the self-employed community. Here she shares simple, straight-forward guides to make self-employment topics like taxes, bookkeeping and banking easy to understand.