Limited company or sole trader – which is best for me?

One of the first tasks you will have when starting up your business will be to decide whether to set up a new limited company, or become self-employed. If you choose to go self employed, this could be either as a sole trader, or as a partner in a partnership.

The different business structures each have advantages and disadvantages, so it’s vital to understand what each offers.

Working out which option best suits you and your new business can take a little time, but it is an important decision and one that can have ramifications over the years ahead.

Here, we look at some of the differences between working as self employed and setting up a limited company;

How are sole traders and limited companies taxed?

Sole Traders

If you are self-employed (as a sole trader or a member of an unincorporated partnership), your business profits and other personal income are taxed via the annual self-assessment process. You cannot defer profits to future years.

For the 2024/225 tax year, the personal allowance is £12,570 – you pay no income tax on this amount. You pay income tax at 20, 40, or 45%, depending on your annual profits.

In addition, you must pay National Insurance Contributions (NICs) on your profits. Class 4 NICs are compulsory – 6% on your earnings between £12,570 and £50,270 and 2% on any further profits. – and paid via self-assessment. Class 2 NICs are voluntary (£3.45 per week).

You can find out more in our sole trader tax guide.

Limited Companies

Limited companies are liable for Corporation Tax on their business profits. Corporation Tax rates increased significantly in April 2023 and are between 19% and 25% – depending on your profits.

Unlike the sole trader route, a limited company can retain profits and distribute them as dividends in future tax years if necessary. The directors may wish to delay paying income tax on dividends during a good year and defer paying dividends to the following tax year.

You can find out more in our corporation tax guide.

What are the benefits of incorporating vs becoming a sole trader?

• One of the main benefits of working via a limited company is that your personal and business finances are distinct, so if a claim is made against your company, you will not be liable personally (assuming nothing illegal has taken place).
• Under the sole trader route, if a financial claim is made against your business, your own finances may also be included in any settlement. If you own a limited company, your personal liability is limited – unless you’ve been negligent.
• Setting up as a sole trader is a straightforward process. All you need to do is inform HMRC of your intention to become self-employed, and you can start trading right away.
• Limited company directors, on the other hand, deal with more paperwork and have various legal and statutory obligations.
• Companies House regulates limited companies, and directors are ultimately responsible for providing accurate and timely accounts annually, even if your accountant does the work.
• Tax-wise, limited company directors can potentially pay less tax, as they can pay themselves small salaries and high dividends free from National Insurance. In contrast, sole traders pay themselves a salary liable for Class 4 NICs and income tax.
• You have more tax-planning opportunities as a company owner. For example, you may decide to split your shares with your spouse. You can also delay paying yourself dividends during the current tax year, to make the most of the tax allowances in a future tax year.
• In some industries (such as professional contracting), you may find that you can only secure work with clients if you work via your own company, so you don’t even have the choice of becoming a sole trader.

In summary

There is no right or wrong business structure, just the one that suits your situation. Once you understand each option’s main benefits, you can make an informed decision. The route you choose is very much up to you.

It is easy to form a limited company if you start out as a sole trader and later wish to expand.

Whatever you decide to do, we recommend discussing your situation with an accountant or business adviser before making the decision.