Sole Trader vs Limited Company – Which Is Right For Me?

Sole trader vs Limited Company

When you decide to set up in business, one of the first decisions you need to make is whether to be a sole trader or limited company. The sole trader vs limited company debate is one that accountants have all the time with their clients. Here are some of the pros and cons of each structure to help you get a better understanding of the implications of your choice.

Sole trader structure

A sole trader business is the simplest structure for a business. It’s quick and easy to set up but this also means that there are some potential downsides to this way of doing business.

Sole trader advantages

As I mentioned, the sole trader business can be very easily set up. Here’s how:

1. Choose a company name. You can trade as yourself or you can choose a business name. If you think you might want to convert to a limited company in the future, it’s worth checking that your chosen name is not the same as a currently trading business on Companies House. You could also choose to register a limited company with your business name to reserve it for future use. There is a charge for this.
2. Start trading. Keep records of invoices and receipts for your self-assessment tax return.
3. Register online with HMRC as self-employed or by phoning the helpline on 0300 200 3310 (best to avoid the last two weeks of January though!)

Sole trader businesses are inexpensive to form and if you are organised with your bookkeeping, you can manage your business with only minimal outgoings for accountancy/tax support. If you’re profits are low in the first few years of business, being a sole trader can be the most cost-effective structure.

If privacy is important to you, the sole trader route may be appealing as your accounts are kept between you, your accountant and HMRC. There is no requirement to file accounts with Companies House that your competitions, family or friends can access.

Sole trader disadvantages

The disadvantages of being a sole trader centre around a lack of separation between you and your business. That means that if your business fails, you will be personally liable for all the costs. You may be able to take out some insurance to cover some of your losses but of course, that increases your business costs. In addition, it is harder to pass on a business thru sale or inheritance if you are set up as a sole trader so this should be considered when deciding on sole trader vs limited company.

Sole traders are taxed under Income tax. This means you’ll pay tax on your profits as follows (correct for tax year 2023/24):

Profits Level (£) Income Tax Rate
0-12,570 0% (this is your personal allowance)
12,571-50,270 20% (basic rate)
50,270-125,139 40% (high rate)
125,140 and over 45% (additional rate)

Depending on your personal circumstances, it may be more beneficial to be taxed under Corporation Tax than having all your profits taxed under Income tax. However, the point at which it becomes tax-efficient will vary from person to person, so you are likely to need advice to establish when it makes sense to convert to limited company status is you are a sole trader.

You face issues with credibility as a sole trader. Some medium and larger companies will only do business with limited companies so a sole trader structure could limit your ability to grow and win more lucrative contracts.

Finally, another potential disadvantage of being a sole trader vs limited company is the lack of funding opportunities. Banks and other investors are unlikely to be persuaded to invest any significant sums into a business with a sole trader structure.

Limited company structure

To set up a limited company in the UK, you’ll need to pick a company name that is not an active company on the list of companies registered with Companies House. It is possible to choose a company name that is the same as a dissolved company because that company has been liquidated and is no longer trading. There are other restrictions on choosing a company name – it must not be too similar to an existing active company and there are company name sensitive words you cannot use without prior permission (link to sensitive words).

Limited company advantages

There are a few advantages of limited companies over sole trader structures. One of the biggest advantages is the legal separation of your business finances from your personal finances. If your limited company business fails, you can only be held liable for the maximum of the nominal value of your shares in the company.

A limited company structure may give your company a more professional status enabling you to win larger clients and larger contracts. As limited companies are monitored more rigorously than sole traders, you are likely to be held in higher regard by potential customers, suppliers, potential employees, investors and other stakeholders. It’s also easier to find funding opportunities for a limited company which can be tricky for sole traders.

Tax efficiency is one of the reasons why business owners choose limited company vs sole trader status. Profits in a limited company are taxed under Corporation Tax on a sliding scale from 19-25% (correct for tax year 2023/24). Limited company directors can choose to take their remuneration as a tax-efficient combination of salary and dividends instead of having all profits taxed as income.

On top of the tax efficiency that comes from being a limited company, you can also make pension contributions as a tax-deductible expense, meaning you can save for your future and reduce present day taxes. This is not available for sole traders.

Limited company disadvantages

Firstly, cost is a consideration for many people looking to set up a business. Registering and managing the compliance for a limited company is more expensive – there are registration costs, annual filing costs as well as accountant fees for preparing your annual accounts and Corporation Tax return. All these costs must be offset against the tax savings if tax-efficiency is a reason why you are considering limited company over sols trader.

Another disadvantage is the public nature of your company finances. You are required to file annual accounts with Companies House so your business finances can be viewed by others. However, at present, small companies can file abridged accounts which includes a basic balance sheet. In future, this is likely to change to increase transparency of company finances and may include information about turnover and profit as well.

Limited companies must record the minutes of company meetings, recording the decisions taken. This adds to the administrative burden of running a company.

Unlike sole traders, there are strict rules about how money is taken out of a limited company. You must either pay directors a salary or declare a dividend from profits or a combination of both. Any other money withdrawn from the company must go through the Directors Loan Account and be repaid within nine months of the accounting year end to avoid additional tax.

Summary of sole trader vs. limited company

Your personal circumstances and the financial situation of the company will determine the best option for your company structure. Here’s a handy table showing summarising the pros and cons of each.

  Limited Company Sole Trader
  • Limited personal liability for debts and legal claims
  • More funding opportunities
  • Business can be co-owned by multiple individuals
  • Tax under Corporation Tax 19-25%
  • More professional standing leading to better contracts and work with larger companies
  • Pension contributions are tax deductible
  • More tax efficient as money withdrawn can be taxed as dividend income
  • Money can be paid to family members as dividends
  • Quick and easy to set up online
  • No need to register with Companies House
  • No registration fee to HMRC
  • Lower startup expenses
  • Owner has full control over the business
  • Easy to remove profits for personal use
  • Minimal accounting costs and requirements
  • Accounts are kept private
  • Minimal paperwork and record-keeping requirements
  • No need to for a registered office address
  • Fewer restrictions when choosing a business name
  • More difficult and expensive to set up
  • Restrictions on company name
  • Required to file publicly available accounts with Companies House
  • Likely to need more expensive accountancy services
  • Must have a registered office where mail can be sent
  • Restrictions on how money is withdrawn from the company – salary or dividends from profits
  • Must maintain a Directors Loan Account
  • Unlimited personal liability for debts and legal claims
  • Obtaining funding is more difficult
  • Business can only be owned by one person
  • Tax under Income Tax – 20-45%
  • May find it harder to get larger contracts as professional status not so highly regarded
  • Pension contributions are not tax-deductible
  • No option to defer withdrawals until a later tax year or reinvest surplus cash without paying tax
  • Unable to issue profits to a spouse or family member as tax-free dividend payments

There’s no single definitive answer to the question ‘Sole trader vs Limited Company- which is better?’ because it depends on a variety of factors and circumstances which differ from person to person. To review your personal situation if you are looking to set up in business, give the Adams Accountancy team a call on 01322 250001 to have a no-obligation chat about how we can support you to make the right decision for you.

In the meantime, you may also find the following blogs useful:

Accounting for beginners: A simple guide for business owners

What to look for in a bookkeeper for a small business

25 reasons why you need an accountant for your small business