Choosing the right structure for your business is one of the first and most important decisions you’ll make as a business owner. That being said, that doesn’t mean you lose the right to switch to a different trading option – as your income grows and your business becomes more established, it’s worth revisiting your set up to see if your model still suits you. For example, many small businesses and freelancers actually start off as sole traders. 

So, sole trader or limited company, which is the better option? This is something we get asked by clients often and the answer is rarely straightforward as it depends on several factors. 

We’re here to break down the age-old question and give you the answers you need to make sure you make the right decision for you. 

Tax efficiency of a limited company 

Here’s the difference between sole trader and limited company tax: 

Sole traders: pay income tax on all profits. This can push you into higher tax bands, meaning you pay a higher rate of tax. 

Limited companies: pay corporation tax on profits (25% for most). The major difference is that you have more control over how you extract income (e.g. combination of salary and dividends) which can help reduce your overall tax burden. 

Essentially, a limited company structure allows you to retain more earnings, plan more strategically, and even defer income for a more efficient tax outcome.  

The downside is that running a limited company comes with greater responsibility, and with greater responsibility comes a lot more admin! For some – especially before they generate consistent profits – the extra admin may not seem worth the switch. It all depends on your individual circumstances and if you have the time and manpower for the added workload. 

Benefits of being a sole trader 

• Easy and quick to set up: minimal paperwork, register with HMRC in minutes 

• Low start-up and running costs: fewer admin fees and no need to register with Companies House 

• Simple tax process: file an annual self-assessment tax return (SATR), no Corporation Tax or Annual Accounts necessary 

• Full control: you make all business decisions and keep full ownership 

• Keep all profits: all earnings are yours after tax – no need to split income 

• Greater privacy: no need to publish accounts or personal details publicly 

• Flexible business model: easy to change direction, pause, or stop trading if needed 

• Eligibility for tax allowances: access to the £1,000 trading allowance and more flexibility to claim business expenses 

Benefits of forming a limited company 

• Limited liability: your personal assets are protected as the company is a separate legal entity. Similarly, there is a clear distinction between personal and business finances 

• Tax efficiency: potential to pay less tax through a combination of salary and dividends 

• Professional image: often seen as more credible and established, especially by larger clients 

• Access to more funding: easier to raise investment or secure business loans 

• Business continuity: the company continues to exist even if ownership or management changes 

• Claim on a wider range of expenses: more allowable business expenses and tax planning opportunities 

• Pension contributions: can make employer pension contributions which are tax-efficient 

Moving from sole trader to limited company 

For tax efficiency purposes, we’d usually suggest making the move from sole trader to limited company when your profits exceed £30,000 annually.  

Another good indication of whether incorporation is the right move for you is if: 

• You plan to hire staff or expand your operations 

• You’re taking on bigger clients or contracts  

• You want to limit your personal financial liability  

• You have long-term growth in mind and want to build your brand and scale soon 

Contrary to what some people think, moving to a limited company structure isn’t just about tax savings, it’s about having greater control over your long-term financial plans and, sometimes, about building up your brand image. 

When does it make sense to run a limited company? 

To summarise, here’s some indicators you can use to work out if running a limited company is more beneficial to you than being a sole trader: 

• You’ve started to take on higher financial or legal risks 

• Your clients prefer to work with limited companies 

• Your profits exceed £30,000 a year 

• You want to separate your business and personal finances 

• You’re planning on expanding your business 

The key is that every business is unique so before you make the leap, we would recommend speaking to a tax professional about your individual position to help you assess your best move. 

Final Thoughts 

There’s a lot of information to take into account in this blog, so it’s natural to feel a little overwhelmed. The good news is that you don’t have to make any decisions alone.  

Whether you’re just starting out or you’re already trading and wonder if you’ve outgrown your trader status, a qualified accountant will be able to advise you. From running a cost-benefit analysis and explaining the pros and cons of each structure in detail to helping you set up your limited company (if that’s your end decision!) and keeping you compliant with HMRC, you know you’re in safe hands.  

Our expert accountants are always on hand for any queries, simply get in touch.