Introduction
Are you deciding between sole trader and limited company? This guide explains the main differences to help you choose the right option for you. It explains that sole traders have more flexibility and less admin but are personally responsible for business debts. Limited companies, on the other hand, protect personal money and can be more tax-efficient, but also have more compliance requirements. Your decision isn’t final – this article also explains how to switch from sole trader to limited company.
Key Takeaways
- Sole trader is easy to set up and run, but you’re personally responsible for any debts the business incurs.
- Limited company is more tax-efficient at higher profits and protects your personal assets, but there are more significant administrative and compliance requirements.
- Business owners often switch from sole trader to limited company when their profits grow, their risk profile increases, or they want to attract more funding.
Sole trader vs limited company: What’s the difference?
| Feature | Sole trader | Limited company |
|---|---|---|
| Legal status | Not legally distinct – you and the business are the same entity. | Separate legal entity registered at Companies House. |
| Set up | Register with HMRC for Self Assessment. | Incorporate online at Companies House. |
| Tax treatment | Income Tax between 20% and 45%. Class 4 national insurance contributions (NICs) on profits over £12,570. Voluntary Class 2 NICs on profits under £6,845. Class 2 NICs are treated as paid when yearly profits are £6,845 or more. | Income Tax and Class 1 NICs through PAYE on your director’s salary. Dividend tax (8.75% – 39.35%) through Self Assessment on dividend income above your personal allowance and the £500 tax-free dividend allowance. Corporation Tax (19% – 25%) on all taxable profits. |
| Privacy | Personal information remains private. | Company information is a matter of public record. |
| Liability | Unlimited – you’re personally responsible for the business’ debts. | Limited liability – your personal assets are protected beyond what you invest in the company. |
| Admin burden | Simple – bookkeeping, annual tax return. | Moderate: Annual accounts, Corporation Tax return, PAYE, Companies House filings. |
| Funding potential | Lower. Many lenders and investors view limited companies as more stable and creditworthy than sole traders. | Higher. Limited companies can find it easier to raise money through bank lending or by issuing shares to investors. |
| Perception | Seen as small and informal. | Seen as professional and credible. |
What is a sole trader?
A sole trader is a self-employed person who owns and operates their business as an individual. For example, a freelance writer or a freelance graphic designer. Setting up as a sole trader is the simplest way to start a business in the UK.
It’s easy to do by signing up for HMRC Self Assessment, which allows you to report your income and expenses and pay the tax you owe. Income tax is charged at 20% on earnings between £12,571 and £50,270 and 40% on earnings between £50,271 and £125,140. Earnings over £125,140 are taxed at 45%.
As a sole trader, you and the business have the same legal identity, and all profits go directly to you. You also face unlimited personal liability, which means you may have to pay any debts the business incurs with your own money, for example, any savings or assets, such as your house.
Filing and administrative requirements for sole traders are minimal; it’s even possible to manage your own accounts and tax returns. As a sole trader, all decisions are made by you. This means you can act quickly without needing to consult anyone else.
What is a limited company?
A limited company is a distinct legal entity separate from its owners. It’s formed by registering as a limited company with Companies House, the UK’s registrar of companies, or with a company formation agent.
A limited company structure lets you own the company by holding shares in it and offers limited liability protection for shareholders and directors. This means that personal assets, such as your house, are protected from business debts.
Limited companies must comply with specific regulations. A limited company provides benefits like tax efficiency and enhanced credibility.
Requirements for UK limited companies
When you set up a limited company, you must take the following steps:
- Prepare annual accounts for both Companies House and HMRC (a legal requirement).
- Keep company records, including some statutory registers, which must be made available for public inspection.
- Register online for Corporation Tax within three months of starting to trade as a limited company.
- Once registered for corporation tax, prepare an annual Company Tax Return and pay Corporation Tax on your company’s profits.
- Register the company as an employer and set up PAYE (Pay As You Earn) before the first payday. This allows you to receive a director’s salary and pay any employees. You can operate PAYE yourself using payroll software, or you can appoint a payroll provider.
- Send a confirmation statement to Companies House every year to verify the company’s registered details.
- If you’re a shareholder as well as a director, file a personal tax return with HMRC.
Sole trader vs limited company: Pros and cons
Sole trader
Pros:
- Quick, easy and free to set up. Register for self-assessment with HMRC.
- Minimal administrative and legal requirements. Bookkeeping and annual tax return only.
- You’re the sole decision-maker.
- Your personal details remain private.
Cons:
- You’re personally liable for any debts incurred by the business. This could put assets such as your house at risk.
- It may not be tax-efficient for larger businesses.
Limited company
Pros:
- Personal assets are shielded from business debts.
- More tax-efficient, especially at higher profit levels.
- Enhanced credibility.
- Easier to get funding. Lenders sometimes consider limited companies to be more stable and credible.
Cons:
- Company details are published on the public record.
- More significant administrative and legal requirements. Annual accounts, corporation tax, PAYE, and filings at Companies House. Some of these tasks can be outsourced to professional experts, such as accountants, to make them more manageable.
When is sole trader status the right choice?
Sole trader status is right if you have a side hustle or if you’re in the early experimental stages of starting a business. It’s also suitable if you’re a freelancer, especially if you offer low-risk services with minimal cost to you. Many entrepreneurs also begin as sole traders.
When should I consider a limited company?
As your profits grow, a limited company becomes more tax efficient. When your risks increase, a limited company offers more protection through limited liability. If you’re looking to grow the business, a limited company provides more financing opportunities. If you’re looking to bid for more work, a limited company offers more credibility. These are all times when it’s better to form a limited company.
Switching from sole trader to limited company
If your income is growing or you want to protect your personal assets from business risks, you may want to change your business structure from sole trader to limited company. The first step is to register as a limited company by applying to Companies House.
You’ll then need to tell HMRC that you’re stopping self-employment and will no longer be a sole trader. To do this, you need to complete the ‘Stopping self-employment’ online form, which you can find when you sign into your online HMRC account.
Transitioning to a limited company: Admin checklist
- Complete a final Self Assessment tax return as a sole trader. The income you report should include your self-employed earnings and tax liability up to the date you stopped being a sole trader.
- Set up a separate business bank account.
- Notify stakeholders such as employees, customers, suppliers, or finance providers that the legal structure of the business has changed. This minimises any risk of confusion or voiding of contracts and ensures that all paperwork and invoices contain the correct details.
Tax advantages and additional reporting
Sole traders pay Income Tax and National Insurance contributions (NICs) on profits above the personal allowance (£12,570 in 2025/26).
Limited companies pay Corporation Tax on their profits, at rates ranging from 19% to 25%. Directors can then pay themselves in two ways:
- A salary, which is deducted before Corporation Tax.
- Dividends, which are paid after Corporation Tax.
Dividends are taxed separately from salary and aren’t subject to NICs, which can make them more efficient at higher incomes. For the tax year 2025/26, the first £500 of dividend income is tax-free. This may be subject to change for further tax years.
Remember that your choice of business structure isn’t final. You can switch from sole trader to limited company when you feel the time is right. For example, when your profits rise, your risk profile increases, or you’re happy to take on more admin. When it’s right for you, switching to a limited company could be easier than you expect, especially with the help of a company formation agent like 1st Formations.
Nicholas Campion
Nicholas is Director, Company Secretarial at 1st Formations, responsible for completing the company’s statutory filings and ensuring all the company secretarial department is fully trained on company law and company secretarial procedures. Nick is also Company Secretary for the BSQ Group and all subsidiary brands, an accredited industry leader and a Companies Act 2006 specialist.
