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Limited Company vs Sole Trader – Which One Should You Choose?
Starting a business in the UK is an exciting journey. One of the first and most important choices you’ll make is how to set up your business. Should you register as a sole trader or form a limited company?
This choice impacts how much tax you pay, your legal responsibilities, and your financial risk. Choosing the wrong structure can lead to higher costs or problems in the future. So, understanding the pros and cons of both options is vital.
This blog will explain the key differences between a limited company and a sole trader. You’ll get a clear picture of how each structure works, their tax rules, and the benefits of both. Let’s help you make the right decision for your business.
What Is a Sole Trader?
A sole trader is the simplest way to run a business in the UK. It means you own the business yourself and there is no legal separation between you and the business.
You can start trading almost immediately. All you need to do is register with HMRC for Self Assessment. You are responsible for paying income tax and National Insurance based on your profits.
However, because there is no legal separation, you are personally responsible for all debts. If your business loses money, your personal assets (like your house or savings) could be at risk.
Example:
Sarah starts a cake business from home. She becomes a sole trader and registers with HMRC. She keeps all profits after tax, but if someone sues her or if the business goes into debt, she is personally responsible.
What Is a Limited Company?
A limited company is a separate legal entity. It exists independently from the people who own and run it. You need to register it with Companies House and follow legal and accounting rules every year.
A limited company protects your personal assets. If the company gets into debt, you are only liable up to the amount you invested. This protection is called t=”2629″ data-end=”2650″>limited liability.
Running a limited company has more paperwork. But it can also bring tax benefits, more credibility, and greater access to finance.
data-end=”2801″>Example:
Tom sets up a digital agency and forms a limited company. The company signs contracts, owns the assets, and handles profits. Tom can pay himself through a mix of salary and dividends, which can be more tax-efficient.
Key Differences: Sole Trader vs Limited Company
1. Liability
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Sole Trader: Full personal liability. If the business owes money, you owe money.
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Limited Company: Limited liability. Your personal finances stay safe unless you break the law or give personal guarantees.
2. Taxation
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Sole Trader: Pays income tax on all profits. Higher profits can mean higher tax rates.
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Limited Company: Pays corporation tax (19% as of 2023/24). Directors can also pay themselves with a low salary and dividends, which are taxed less.
3. Administration
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Sole Trader: Fewer rules. One tax return a year.
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Limited Company: Must file annual accounts, confirmation statements, and corporation tax returns.
4. Privacy
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Sole Trader: Your details stay mostly private.
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Limited Company: Company details, including directors’ names and addresses, are publicly listed on Companies House.
Tax Breakdown: What You’ll Pay
Sole Traders
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Income Tax:
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20% basic rate
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40% higher rate
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45% additional rate
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National Insurance:
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Class 2 NICs: £3.05 per week
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Class 4 NICs: 9% on profits from £9,568 to £50,270, then 2% on anything above
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Limited Companies
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Corporation Tax: 19% on company profits
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Dividends:
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8.75% (basic rate)
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33.75% (higher rate)
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39.35% (additional rate)
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Employer Contributions: Pension payments are tax-deductible for the business
Advantages of a Limited Company
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Tax Efficient: You can take a salary and dividends to reduce personal tax.
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Limited Liability: Your personal assets are protected.
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Credibility: Many clients and lenders prefer dealing with companies.
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Investment Friendly: You can issue shares and bring in investors.
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Growth Ready: Suits businesses planning to expand.
Advantages of a Sole Trader
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Simple Setup: Register with HMRC and start trading.
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Low Costs: No Companies House fees or accountancy costs.
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Full Control: You make all decisions.
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Flexible: You can change direction or close the business easily.
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Close Customer Ties: Personalised service often leads to stronger relationships.
Which Structure Is Best for You?
Ask yourself:
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Do you want full control and easy setup? Go with a sole trader.
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Do you want to protect your assets and save tax long-term? Consider a limited company.
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Do you want to raise investment in the future? A company will be more suitable.
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Is your business high-risk? Limited liability is crucial for protection.
Common Myths Busted
“Only big businesses need to be limited companies.”
False. Even small businesses can benefit from tax savings and limited liability.
“Sole traders pay less tax.”
Not always. As profits grow, limited companies can be more tax-efficient.
“You can’t switch structures later.”
You can. Many sole traders move to limited company status as they grow.
Tax Tips for Both Setups
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Keep Records: Track every expense, receipt, and invoice.
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Claim Expenses: From fuel to subscriptions, deduct every allowable cost.
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Consider Pensions: Contributions are tax-efficient for both sole traders and companies.
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Balance Salary & Dividends: If you’re a company director, mix both to reduce your tax bill.
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Hire a Tax Adviser: A professional can help you save money and avoid penalties.
Conclusion: Make the Right Choice Today
Choosing between a limited company and sole trader setup affects how much tax you pay, your legal risk, and how easily your business can grow. Sole traders enjoy simplicity and independence, while limited companies offer tax advantages, credibility, and asset protection.
Think about your risk level, how much you expect to earn, and your long-term goals. There is no “one-size-fits-all” solution. But with the right advice and a clear plan, you can set up your business the smart way.
Make your decision with confidence and lay the foundation for lasting success.
If you would like further assistance with this or anything else, please get in touch, contact us for expert assistance.
