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Sole Trader vs Limited Company? What’s Better?

Building a business is complicated enough without the added confusion of choosing a business structure. If you’re stuck in the sole trader vs Limited Company dilemma then this guide is for you. Here, you’ll find out the difference between becoming a sole trader or a Limited Company. In addition, I’ll outline other key points such as tax benefits, reporting requirements and the truth about protecting your personal assets.

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. What is a Limited Company?

A Limited Company is a type of UK business structure used by some to run their businesses through. It has its own separate business entity responsible for its own liabilities, contracts, money etc. Think of it like a completely different person from yourself, responsible for taking care of all your business obligations. This includes having its own separate bank account to spend/receive money, owning all your business contracts, and with its own specialist tax/accounting rules to follow.

In order to run the business, a Limited Company has directors who are named individuals responsible for running the company. It’s these Directors whose duty it is to run the business successfully. They have to follow the rules of the Limited Company (set out in the Company rulebook called the Articles of Association) and ensure all filing deadlines are adhered to.

2. What is a Sole Trader?

A sole trader (also referred to as self-employed) is a person who works for themselves as an incorporated business. Unlike a Limited Company, sole trader businesses are not legally separate entities from their owners.

Registering as self-employed (or sole trader) is the quickest way to start a new business. However, even though all the money you make belongs to you, you are also personally liable for all the debts.

3. What’s the Main Difference Between a Sole Trader and a Limited Company?

The main differences between being a sole trader or Limited Company are personal liability, reporting requirements and the tax side of things.

3.1 Personal Liability

A limited company is a separate legal entity from its Directors and Shareholders. This means it is responsible for its own debts such as taxes, purchase invoices and loans. Sole traders are not legally separate from their business, so you’ll be liable for all your business debts. In the event you can’t pay a bill, a supplier will be coming after you personally. This can affect your credit report.

Although a Limited Company does offer protection of your personal assets, the reality is that protection it offers can be overridden in certain circumstances such as:

  • Banks & lenders are more commonly requesting personal guarantees of loans and overdrafts. This makes you ultimately responsible for paying back debts regardless of Limited Company status;
  • If you were considered to be doing anything wrongful or fraudulent by HMRC or Companies House as Director of a Limited Company, it’ll become your responsibility to repay and rectify any issues;
  • If as a Director, you were deemed to have taken out too much money, either by loans or dividend from your Limited Company, you’d be required to repay the money again putting your personal assets at risk;
  • Or, if you were trying to wind up your business without paying taxes. It’s worth knowing that HMRC has the power to prevent you from shutting down your Limited Company until you pay the unpaid amounts.

3.2 Reporting Requirements

Once you are registered as a sole trader, you’ll need to report your earnings for tax year, once a year on a self-assessment tax return due by 31 January. Additionally, tax payments are due by this date, with a mid-year tax installment due by 31 July (aka a payment on account).

Many sole traders opt to fill in their tax returns themselves. This is usually if their affairs are fairly simple to avoid the cost of an accountant. However, things can be complicated with a Limited Company.

A registered Limited Company has the following reporting requirements:

  • Annual Company Accounts with Companies House (including a balance sheet)
  • An annual confirmation statement with Companies House
  • HMRC corporation tax return

In addition, you need to separately report any changes to things like registered office, directors or shareholders. Therefore, if you form a Limited Company, it is advisable to use an accountant to take care of all the filings and returns.

3.3 Tax

You’ll be taxed on your business profits and need to pay:

  • Income tax
  • Class 2 National Insurance
  • Class 4 National Insurance

The amount of each that you pay depends on how much profit you make. You can read more about self-employed tax in this guide, see some examples of how to calculate it and when you pay it. This includes if you’re employed and self-employed.

A Limited Company pays corporation tax at 19% on the first £300,000 of business profits.  To pay yourself from your Limited Company, you can choose to take a dividend (and pay dividend tax) or PAYE salary (and pay income tax and National Insurance). Getting the combination of salary and dividend right can be tax efficient. This is because it takes advantage of lower tax rates and tax-free allowances. Read this guide to find out how to pay yourself from your Limited Company.

4. Sole Trader vs Limited Company? What’s Better for Tax?

Whether a sole trader or Limited Company is better for tax depends on your personal circumstances and the profit your business makes. I’ve created a comparison calculator to help you decide which business structure is saves you the most tax. Just input your profits in the purple box at the top and the calculator will work it out for you.

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

sole trader or limited company
Sole Trader or Limited Company Comparison Calculator

5. Sole Trader vs Limited Company? What’s Better?

Deciding which business structure is better for you can be a tricky decision because it depends on lots of factors. If you are simply looking at tax savings, accountants normally recommend forming a Limited Company when your business profits reach £50,000. At this point, tax savings tend to outweigh their fees. I’d always recommend using an accountant if you have a Limited Company because the reporting is more complicated and it’s worth having an expert calculate how you pay yourself to make the biggest tax savings.

If you are new to self-employment, then you could take advantage of the £1,000 trading income allowance which lets you earn £1,000 in income (not profit) without the need to register with HMRC or let them know about your income.

Once you pass the £1,000 income limit, registering as a sole trader is your next step. And, with the more simple reporting you can choose to fill in your own tax return. This can avoid the cost of hiring an accountant. You’ll need to report your income and expenses to HMRC instead of full accounts and corporation tax returns involved in having a Limited Company.

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. If you do this, you’ll only need to deal with very minimal filing requirements but have your LTD name ready for when you need it.