Sole Trader vs Limited Company: Which Structure is Right for You?

Sole trader basics

A sole trader is the simplest business structure. You and your business are legally the same entity. There is no formal registration beyond notifying HMRC for Self Assessment. You can start trading immediately and keep all profits after tax.

The simplicity comes with a trade-off: unlimited liability. If the business fails, you are personally liable for all debts. Creditors can pursue your personal assets including your home. This risk is acceptable for low-liability businesses but dangerous for others.

• Quick and free to set up
• Simple tax through Self Assessment
• Keep all profits after tax
• Unlimited personal liability
• Less administrative burden
• Business income is your personal income

Limited company basics

A limited company is a separate legal entity from its owners. The company owns assets, enters contracts, and is liable for debts. Shareholders' liability is limited to their investment, protecting personal assets if the business fails.

This protection comes with requirements. You must register with Companies House, file annual accounts, and follow corporate governance rules. Directors have legal duties and the company pays Corporation Tax on profits.

• Separate legal entity from owners
• Limited liability protects personal assets
• Corporation Tax on company profits
• More administrative requirements
• Greater privacy controls available
• Extract profits through salary and dividends

Tax comparison at different income levels

At lower income levels (under GBP 30,000 profit), sole traders often pay similar or less tax due to simpler structures and no employer NIC on dividends extraction. The admin savings also have value.

At higher income levels (GBP 40,000+), limited companies typically offer tax savings. Corporation Tax is 25 percent (or 19 percent marginal rate for small profits) compared to 40 percent income tax plus National Insurance. Extracting profits as dividends is taxed at lower rates than salary.

National Insurance differences

Sole traders pay Class 2 NIC (flat rate) and Class 4 NIC (percentage of profits). Combined, this is typically lower than employed NIC but applies to all profits.

Limited company directors taking salary pay employee NIC, and the company pays employer NIC at 13.8 percent. However, dividends do not attract NIC. By keeping salary low and taking dividends, total NIC is often much lower.

Administrative burden

Sole traders file one Self Assessment return annually. Basic bookkeeping records of income and expenses are sufficient. There are no filing requirements beyond tax returns.

Limited companies file annual accounts with Companies House, Corporation Tax returns with HMRC, annual confirmation statements, and potentially payroll returns. Directors must maintain statutory registers, hold board meetings, and document decisions. The admin cost is real.

• Sole traders: Self Assessment return annually
• Ltd companies: Accounts, CT return, confirmation statement, payroll
• Ltd companies require Companies House filings
• Ltd companies need statutory registers and minutes
• Most Ltd company owners use accountants for compliance

Liability and risk

Sole traders face unlimited personal liability. If the business is sued, owes money, or fails, personal assets are at risk. This is fine for low-risk consulting but dangerous for businesses with significant liabilities.

Limited liability means shareholders only risk their investment. Personal assets are protected from business debts. However, directors can still face personal liability for wrongful trading, personal guarantees, or director loans not repaid.

Perception and credibility

Some clients and suppliers prefer working with limited companies. The Ltd suffix suggests permanence and professionalism. Larger organisations may require limited company status for their supply chain.

For many small businesses serving consumers, structure is irrelevant to customers. A plumber, designer, or consultant can build an excellent reputation as a sole trader.

When to consider incorporation

Consider incorporating when profits consistently exceed GBP 30,000-40,000, when you want to protect personal assets from business risks, when you are bringing in investors or partners, or when clients require limited company status.

Timing matters. Incorporation transfers your business to a new entity with potential Capital Gains Tax implications. Planning the transition properly minimises tax and ensures continuity.

Can you switch later?

Yes, you can incorporate a sole trader business into a limited company. The process involves transferring assets, clients, and contracts to the new company. Done properly, existing goodwill can often transfer tax-efficiently.

Going the other way (dissolving a company to trade as sole trader) is less common but possible. Usually this happens when a business scales down or when the admin burden no longer justifies limited status.

Key takeaways

• Sole trader is simpler but offers no liability protection
• Limited company offers tax savings at higher income levels
• Admin burden is significantly higher for limited companies
• Consider incorporation when profits exceed GBP 30,000-40,000
• Limited liability protects personal assets from business debts
• You can switch from sole trader to limited company later
• Get professional advice before incorporating

How we can help you

We specialise in:

• Sole trader to limited company incorporation
• Company formation and setup
• Tax structure planning
• Self Assessment preparation
• Company accounts and returns

Not sure which structure is right for you? K&R Accountants can model both options based on your specific circumstances. Book a free consultation.