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 their own advantages and disadvantages, so it’s vital you understand what each offers you.

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 is taxed via the annual self assessment process. You cannot defer profits to future years.

For the 2021/22 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 2 NICs are £3.05 per week (2021/22 tax year), and HMRC will calculate your Class 4 NICs on your annual profits.

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

Limited Companies

Limited companies are liable for Corporation Tax on their business profits. The Corporation tax rate is currently 19%.

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 personal finances may also be included in any settlement.
  • Setting up as a sole trader is a very simple process. All you need to do is inform HMRC of your intention to go self employed, you can start trading right away.
  • Limited company directors, on the other hand, have to deal with more paperwork, and have various legal and statutory obligations.
  • Limited companies are regulated by Companies House, and directors are ultimately responsible for providing accurate and timely accounts on an annual basis, even if your accountant does the actual work.
  • Tax-wise, limited company directors can potentially pay less tax, as they can pay themselves small salaries and high dividends which are free from National Insurance, whereas sole traders pay themselves a salary which is liable for Class 2 and 4 NICs as well as 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 individual situation. Once you have an understanding of the main benefits of each option, you can make an informed decision. The route you choose is very much up to you.

If you start out as a sole trader and later on wish to form a limited company, it is easy to do so.

Whatever you decide to do, we always recommend you discuss your situation with an accountant or business adviser before going ahead.

Last updated: 22nd March, 2022

Combine all of your old pensions into one simple online plan

Sign up in 5 minutes - over 600,000 users, including the Bytestart team!

Superscript no-ties business insurance - pay monthly

Tailored just for you + pay monthly. You could be covered in just 10 minutes.

Tide Business Bank Account - £40 welcome bonus!

Exclusive for Bytestart readers + 12 months' free transfers. Find out more.

FreeAgent Online Accounting - 55% off - ByteStart exclusive!

Brilliant software. Get 55% of your first 6 months, then 10% for life.

Related articles

  • sole trader vs limited

    7 ways being a sole trader is better than working via a limited company

    For those new to the world of business, there are many things to consider. One of the biggest decisions you’ll have to make when you’re starting a business is whether to set up as a…

  • board meeting minutes

    Why are board minutes so important?

    Board minutes are a vital part of a successful business. They ensure directors are upholding their duties and act as a reminder for decisions made during board meetings. Related guides: What is Companies House? What…

  • set up a limited company

    How to set up a limited company – the basics

    Everything you need to know about setting up a limited company in the UK; The information you need to hand in, plus the costs and options available to you.