Contents
Should I be a sole trader or limited company? The answer to this is, of course, subjective. There are a lot of factors to consider, and your decision usually narrows down to which one is the most tax-efficient and manageable for you.
Seek tax and business advice if you are unsure how to start your business or freelancing. For now, here are the areas you need to consider. If you are already a sole trader and thinking about shifting, this guide is also for you.
Difference Between Sole Trader and Limited Company
The major difference between a sole trader and a limited company is the legal structure. As a sole trader, you are one with your business. As an owner (i.e., shareholder) or director, you are a separate entity from your limited company.
Most especially, tax implications vary. Sole traders pay income tax and National Insurance on all business profits through Self-Assessment tax return. Limited companies (e.g., LLC, LLP), on the other hand, pay corporation tax.
On the surface, operating as a limited company offers greater flexibility (take, for instance, tax-strategic withdrawal of salary and dividends), but there are several factors to consider (more below).
Most people start as a sole trader then switch to a limited company, as this option is easier. You can always change structures as needed. Be sure to consult a tax and financial advisor to ensure a strategic approach.
Here’s more information about what being a sole trader means.
Key Areas to Consider When Choosing Structure
First, assess yourself in these areas:
- Your growth ambitions. Do you plan to scale and expand someday? If so, limited company is best option.
- Ease of management. How much administrative work are you willing and able to handle?
- Legal protection. How much is your risk tolerance?
- Tax implications. Be sure to understand sole trader vs limited company tax.
- Control and profits. Do you want complete control over your business operations and to retain all profits directly? In this case, sole trader suits you.
- Funding needs. Do you anticipate needing access to further funding or investment? A limited company structure may be more suitable.
- Work-life balance. Is flexibility in setting your own hours a priority for you? This is often easier as a sole trader.
- Income level. How much do you earn in a year on average? Generally, sole trader can be more efficient at lower profits, whilst a limited company may save more on higher profits.
- Setup costs. How much are you willing to invest from the initial stage?
An accountant or advisor can assess your specific business needs and run the numbers for you. Knowing the pros and cons of both structures can help you decide more properly.
Advantages of Sole Trader vs Limited Company
Let’s see how you can benefit from each structure.
Advantages of Sole Trader Over Limited Company
- Simplicity – Fewer legal and financial requirements, making setup and running easier, especially on a smaller scale.
- Less Administration – Generally less paperwork and fewer filing requirements compared to a limited company, saving time and potentially accounting costs.
- Complete Control – You have full autonomy over business decisions and retain all profits after tax.
- First-Year Tax Flexibility – Business losses in the first year can potentially reduce other tax owed and possibly lead to a refund.
- Tax Efficient at Lower Profits – Can be the most tax-efficient structure when business profits are lower.
- Keep All Profits – You retain all business profits after paying income tax and National Insurance.
- Trading Allowance – Depending on circumstances, you might be able to use the trading allowance (up to £1,000 tax-free for the current tax year).
- Default Cash Basis Accounting – Sole traders typically use cash basis accounting by default (simplified method).
- Simplified Expenses – Access to flat-rate simplified expenses for some business costs (e.g., working from home, vehicle expenses) not available to limited companies.
- Capital Gains Tax Advantages – Sole traders and partnerships pay capital gains tax on selling business assets and have access to various tax reliefs not applicable to limited companies (which pay corporation tax on asset sales).
- Privacy – Your annual accounts are private between you and HMRC, unlike the public records of a limited company.
- Easier Structure Change – Switching from a sole trader to a limited company is generally simpler than the reverse.
Relevant read: Can a Sole Trader Be VAT Registered UK?
Advantages of Limited Company Over Sole Trader
- Limited Liability – Protection of personal assets from business debts is one of the most attractive benefits of limited company.
- Tax Efficiency – Often more tax-efficient, as limited companies pay corporation tax on profits (potentially lower than income tax) and can use dividends for tax-efficient income.
- Easier to Raise Capital – Issuing shares makes it generally easier to attract investment for business growth and expansion.
- Business Continuity – The company exists as a separate legal entity and can continue even if owners leave, facilitating long-term legacy building.
- Greater Growth Potential – Easier to scale and grow by attracting more shareholders and securing investment.
- Professional Image – Often perceived as more credible and stable by clients, suppliers, and investors.
- Pension Contributions – Company pension contributions can be made to reduce company tax.
Relevant read: Does a Sole Trader Pay Corporation Tax?
Disadvantages of Sole Trader vs Limited Company
Each business structure also has its disadvantages.
Disadvantages of Sole Trader
- Unlimited Personal Liability – You are personally responsible for all business debts, putting your personal assets at risk if the business fails.
- Lower Perceived Prestige – Some clients and suppliers may view sole traders as less established or stable compared to limited companies. This can potentially hinder business opportunities.
- Limited Tax Planning – Fewer options for tax optimisation compared to limited companies, such as not being able to draw dividend income taxed at a lower rate.
- Difficult to Raise Finance – Securing significant loans or investment can be harder as lenders and investors may see sole traders as higher risk.
- Sole Responsibility – Running all aspects of the business alone can be stressful and time-consuming.
- Harder to Transfer Ownership – Passing the business on through inheritance or sale is more complex than with a limited company (transferring shares).
- Less Tax Efficient at Higher Profits – Once profits exceed a certain level (around £20,000 to £30,000), you may pay more personal tax as a sole trader compared to a limited company.
Learn how to how to reduce income tax in this guide.
Disadvantages of Limited Company
- Complex Setup and Administration – More paperwork involved, including registration with Companies House (with a fee) and ongoing filing of annual accounts and reports.
- Greater Responsibility for Directors – Directors have legal duties to run the company lawfully, with potential penalties or disqualification for failing to meet these.
- Limited Financial Privacy – Company accounts are publicly available through Companies House.
- Potential for Conflict – Disagreements can arise among multiple shareholders regarding company direction or profit distribution.
- Tax Administration Complexity and Potential Double Taxation – The company pays corporation tax on profits, and directors pay income tax and National Insurance contributions on salaries. Dividends are also subject to income tax (also known as dividend tax) after corporation tax.
- Higher Running Costs – Costs associated with setting up and running a limited company, including accountancy fees, Companies House fees, and potentially higher banking charges.
- Difficult to Close Down – Dissolving a limited company (bankrupt or for other reasons) can be a complex and potentially costly process.
- More Restrictions on Loss Relief – When a limited company makes a loss, it can generally only use that loss against its own future profits, unlike sole traders who might offset losses against other income.
- Directors Not Free to Draw Money – Directors cannot freely withdraw money from the business account; income is typically taken as salary or dividends, both subject to tax.
- Legal Formalities for Everything – More formal processes required for various business decisions and actions compared to a sole trader’s flexibility.
- Potential Need for Payroll – If taking a salary as a director, the company needs to register as an employer and operate payroll.
- Publicly Available Office Address – The company’s registered office address is public (an issue of privacy if it is your home).
- May Need Personal Guarantees – Directors may be asked to personally guarantee loans or large credit agreements.
Relevant read: Do You Pay Corporation Tax on Dividends?
Frequently Asked Questions
Can I change from being a sole trader to a limited company?
Yes, transitioning from a sole trader to a limited company is a common option for growing businesses. This involves registering the company and informing HMRC of the change.
Can a sole trader be a limited company?
No, a business cannot operate as both a sole trader and a limited company at the same time as they have different legal structures and tax treatments.
How to transfer assets from limited company to sole trader?
You need to consider your tax liabilities and choose appropriate banking solutions when transferring assets. Be sure to seek professional advice from an accountant or tax specialist to ensure legal compliance during this transition.
When should I change from sole trader to limited company?
When your business profits grow significantly (around £25,000 to £30,000), or when you need limited liability and plan for expansion or investment. Discuss the implications with a financial advisor first.
Get Advice from Legend Financial
Should I be a sole trader or limited company? Both have their pros and cons, so be sure to assess your goals and needs closely. Legend Financial is here to help. We have been helping hundreds of sole traders and limited companies with their tax and business affairs for over a decade. Let’s discuss your situation and see how we can help.
