Growth is the dream, isn’t it?

Your freelance work is taking off. What started as a weekend project is now bringing in serious money, and you’re wondering whether it’s time to make this official.

This step-by-step guide will walk you through each stage of the freelancer’s financial journey, so you know exactly when and how to make each transition.

Stage 1: How to set up your side hustle properly (Under £1,000 annually)

When you’re at this stage: Your freelance income is sporadic, maybe a few hundred pounds here and there. You’re testing the waters and building your skills.

Step 1: Understand your tax position

At this level, you’re covered by the £1,000 trading allowance, which means your freelance income is completely tax-free. You don’t need to register for Self Assessment or tell HMRC anything about this income.

However, keep basic records anyway – a simple spreadsheet tracking income and expenses will do. You’ll thank yourself later when your income grows and you need historical data.

Step 2: Set up financial foundations

Even at this early stage, start building good habits:

• Open a separate savings account for your freelance income (doesn’t need to be a business account yet)
• Keep all receipts for any expenses, even small ones like website hosting or office supplies
• Track your time to understand your real hourly rate

Step 3: Test your market value

Use this stage to experiment with pricing. Since you’re not relying on this income, you can afford to test higher rates and see what the market will bear.

Red flag to watch for: If you’re consistently earning close to £1,000 annually, start planning for Stage 2. Don’t wait until you’ve exceeded the limit to get organised.

Stage 2: How to transition to sole trader self-employment (£1,000 – £50,000 annually)

When you’re at this stage: Your freelance income has exceeded £1,000 or you’re confident it will soon. You need to get properly set up as a sole trader.

Step 1: Register with HMRC

You must register as self-employed within 3 months of earning over £1,000 from freelancing. This is free and can be done online at gov.uk.

What you’ll need:

• Your National Insurance number
• Details of what services you provide
• Expected annual income
• Start date of your self-employment

Step 2: Establish proper business banking

Open a dedicated business bank account. Many banks offer free business banking for new sole traders but compare the ongoing costs and features.

Look for accounts that offer:

• No monthly fees for the first 12-18 months
• Integration with accounting software
• Mobile banking and easy expense categorisation

Step 3: Implement professional bookkeeping

Invest in cloud accounting software like FreeAgent, Xero, or QuickBooks. Yes, it costs £10-£20 monthly, but it will save you hours at tax time and provide valuable business insights.

Set up your chart of accounts to track:

• Different income streams
• Office expenses
• Travel and subsistence
• Equipment and software
• Professional cost such as accountancy, legal and insurance
• Advertising and marketing expenses and any other major categories applicable to your business

Step 4: Understand your tax obligations

As a sole trader, you’ll pay:

• Income tax on your profits (after expenses)
• Class 2 National Insurance if profits are below £6,725 annually you can elect to pay voluntary contributions at a rate of £3.45 per week
• Class 4 National Insurance at 9% on profits between £12,570 and £50,270

Key deadline: Submit your Self-Assessment by 31st January following the end of the tax year, and pay any tax due.

Step 5: Plan for tax payments

Start setting aside 25-30% of your profits for tax. Set up a standing order to transfer this automatically to a separate tax savings account every month.

Pro tip: Complete your Self-Assessment as early as possible after 6th April. This gives you almost 9 months to save any tax owed rather than scrambling in January.

Stage 3: How to optimise your sole trader setup (£20,000 – £85,000 annually)

When you’re at this stage: Your freelance work is now substantial income. You might be considering going full-time or you’re already there.

Step 1: Maximise your allowable expenses

At higher income levels, proper expense management becomes crucial. Ensure you’re claiming:

• Home office expenses using either the flat rate (£6 per week) or actual costs method
• Professional development courses, books, and training
• Equipment and software including computers, phones, and subscriptions
• Travel costs for client meetings and business purposes
• Professional services like accountancy and legal fees

Step 2: Consider pension planning

Self-employed pension contributions offer significant tax relief. You can contribute up to £40,000 annually (or your earnings if lower) and get tax relief at your marginal rate.

Example: If you’re a higher-rate taxpayer contributing £5,000 to your pension, you’ll save £2,000 in tax (40% relief).

Step 3: Monitor the VAT threshold

Keep a close eye on your income approaching £90,000. You must register for VAT within 30 days of exceeding this threshold.

Planning options:

• Register voluntarily before hitting the threshold to control timing
• Consider whether you can legitimately split services to stay below the threshold
• Build VAT into your pricing structure in advance

Step 4: Plan for growth investments

At this income level, you should be reinvesting in your business. Consider:

• Professional website design
• Marketing and advertising
• Better equipment and software
• Professional qualifications or certifications

Stage 4: How to move from sole trader to limited company status (£50,000+ annually)

When you’re at this stage: Your profits are substantial enough that the tax savings and professional benefits of incorporation outweigh the additional complexity. It’s time to take the plunge and switch from sole trader to limited company.

Step 1: Understand when incorporation makes sense

Limited company status may become more attractive when:

• Your profits exceed £50,000 annually
• You want to retain profits in the business for future investment
• Clients prefer working with limited companies
• You want limited liability protection

Step 2: Set up your limited company

You can do this yourself through Companies House for £34, but professional help ensures you get the structure right from the start.

Key decisions to make:

• Company name and registered address
• Share structure (especially if involving family members)
• Directors and their responsibilities
• Financial year end date

Step 3: Implement company accounting systems

Limited companies have more complex requirements:

• Corporation tax returns due 9 months after year-end
• Annual accounts filed at Companies House
• Confirmation statements filed annually
• PAYE setup if taking a salary

Step 4: Optimise your salary and dividend strategy

The most tax-efficient approach typically involves:

• Taking a small salary (around £5,000-£12,570)
• Drawing remaining income as dividends

Current tax efficiency example:

• Salary of £12,570: Costs £1,136 in employer NI, but qualifies for state pension
• Dividends: Taxed at 8.75% (basic rate) or 33.75% (higher rate) with no National Insurance

However, see our recent blog about the impact of employer’s NI changes for sole limited company directors in 2025.

Step 5: Transfer your sole trader business

You’ll need to:

• Transfer business assets to the company
• Inform clients of the change
• Complete a final sole trader tax return
• Start operating through the company

Important: Consider the timing carefully. You might want to align this with the start of a new tax year to simplify accounting.

Advanced considerations: How to optimise your limited company

Pension strategy optimisation

Company pension contributions are incredibly tax-efficient:

• No employer National Insurance on contributions
• Corporation tax relief for the company
• No income tax or employee National Insurance for you

Family member involvement

If your spouse isn’t working or earns less than you, consider making them a shareholder. This can utilise their tax allowances and basic rate band.

Expense planning

Limited companies can claim for:

• Directors’ training and development
• Business entertainment (within limits)
• Company cars and associated expenses
• Professional memberships and subscriptions
• Annual staff party and trivial benefits

Making the right move at the right time

The key to this journey isn’t rushing to the ‘end goal’ of limited company status – it’s making the right choice for your current situation and planning for the next stage.

Stage transition checklist:

✓ Monitor your income levels monthly

✓ Plan transitions at the start of tax years where possible

✓ Get professional advice before making major changes

✓ Keep detailed records throughout every stage

✓ Build relationships with professional advisers early

Remember, there’s no universal ‘right’ structure – only what’s right for your business at its current stage. Some freelancers are perfectly happy remaining as sole traders throughout their careers, while others benefit from early incorporation.

Ready to make your next move?

Get in touch with us for free review of your current position. Our friendly team can help you plan the most tax-efficient route forward – either  optimising your sole trader setup or making the leap to limited company status. After all, every successful business started as someone’s side project – let’s make sure yours develops in the most profitable way possible.