As a self-employed person starting a new business, one of the crucial things you’ll need to decide on is the right business structure for you. The two most common options are operating as a sole trader or setting up a limited company. 

Each option has its own advantages and disadvantages, and the choice you make will have a significant impact on the legal, financial and operational aspects of running your business. 

The main difference is that a Sole Trader and their business are legally the same, while a Limited company is a completely legal entity. This means that a Sole Trader would be personally responsible for business debts, whereas a Limited Company director has limited liability.

Tax is another important difference. Sole Traders generally pay Income Tax and National Insurance on their taxable profits. A Limited Company pays Corporation Tax on its taxable profit, while the people who own or work for the company may also pay personal tax on money they receive from it.

In today’s article, we'll delve into the differences between sole traders and limited companies, as well as breaking down their pros and cons, to help you determine which suits your business best.

Sole Trader vs Limited Company at a glance

Let’s start with the questions you need to ask yourself before setting up your business: 

Key considerations when choosing the right structure for your business

The decision between being a sole trader or setting up a limited company ultimately depends on your business goals, the industry you’re working in and your personal preferences. Before choosing how to set your business up, ask yourself:

• Where do I see my business going?
  If you have ambitious plans for growth and plan to seek out external investment, a limited company could provide more avenues for funding. On the other hand, if you’re planning to freelance as a side hustle, becoming a sole trader might be your best bet.
  
  
• Do I plan to hire employees?
  Both Sole Traders and Limited Companies can employ people. If you plan to hire employees, you’ll have additional responsibilities regardless of business structure, including registering as an employer and running payroll. However, a Limited Company structure might provide more formal HR and legal frameworks for hiring and employment contracts. As a Sole Trader, it can be harder to engage and compensate your workers.
  
  
• What is my risk tolerance?
  If you're risk-averse and want to protect your personal assets, a limited company might be a better choice, as it means your personal assets will stay separate from the company's finances.
  
  A Limited Company is legally separate from its owners, which generally provides limited liability. However, limited liability isn’t absolute, and there are some circumstances where directors or shareholders can still have personal liability.
  

• Which structure would be more tax and cost-effective?
  This is one of the biggest questions people ask when deciding between a Sole Trader and a Limited Company, but there isn’t a single answer that applies to everyone. As a Sole Trader, you pay Income Tax and National Insurance based on your taxable profits. A Limited Company pays Corporation Tax on its taxable profits. You may then also pay personal tax on money you take from the company, such as salary or dividends.
  
  This means you shouldn’t assume that a Limited Company will automatically mean paying less tax. The most tax-efficient structure depends on your individual circumstances, including your profits, other income and how much money you take from the business.
  
  
• How do I want or need my business to be perceived?
  If your industry demands a high level of credibility, having a limited company might be more appealing to clients and partners.
  
  
• How comfortable am I with admin?
  If keeping the paperwork to a minimum is at the top of your priority list, you might be better off becoming a sole trader (and avoiding the Annual Accounts, Corporation Tax Returns and IR35s that limited companies have to file each year). That said, each route does come with some admin and tax responsibilities, and whether you go the sole trader or limited company route, you’re not on your own. You can always consult a tax advisor or professional accountant to help you stay compliant and on top of your tax obligations. 

Now that you’ve got your own business ambitions and personal preferences a little clearer in your head, let’s get into the pros and cons of running your business as a limited company or sole trader:

Running your business as a sole trader

A sole trader is an individual who runs their business as the sole owner and operator. This structure is popular with freelancers (especially those with side hustles), consultants and small-scale entrepreneurs due to its simplicity and ease of setup. Here are some of the main advantages and disadvantages of being a sole trader:

The pros:

• It’s easy to get started: Setting up as a sole trader is straightforward and requires minimal legal formalities, as you won’t need to employ a solicitor or company formation agent. You'll need to register for self-assessment with HMRC, but beyond that, you're ready to go. 
• Greater control: As a sole trader, you have full control over your business decisions. You can implement changes quickly and adapt to market demands without consulting anyone else.
• More privacy: As a sole trader, you’re protected by HMRC’s taxpayer confidentiality rules, so others won’t be able to find details about your accounts, directors and finances online.
• Less admin: As we touched on earlier, you’ll have less paperwork as a sole trader compared to a limited company. You’ll really only need to register for Self Assessment and file your annual Self Assessment tax return. 

The cons:

• Personal liability: One of the significant drawbacks of being a sole trader is that you have unlimited personal liability. This means that your personal assets could be at risk if your business incurs debts or legal issues. 
• Limited growth: Operating as a sole trader might limit your ability to access certain funding options, as investors and lenders might be more inclined to work with limited companies.
• Credibility: Some clients and customers may perceive limited companies as more professional and stable compared to sole traders.

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Is a Limited Company more tax-efficient than being a Sole Trader?

Not necessarily, but often it can be. This is one of the most common questions people ask when deciding whether to operate as a Sole Trader or set up a Limited Company. There isn’t a single profit level where becoming a Limited Company automatically always becomes more tax-efficient. However, if your taxable income is approaching £50,271 a year, it’s worth reviewing whether your current business structure still works for you. 

The main reason being that Limited Company directors can take a mixture of salary and dividends if the business profits allow, which can often result in more take-home pay. Let’s break down how that might look with an example.

*This is looking at personal NI. The company may also have employer's NI on the salary, which is a company cost rather than a deduction from the director's £12,570 salary. Employer NI is 15% above the £5,000 secondary threshold in 2026/27. 

Please note that this is an illustrative comparison rather than a calculation of the total tax costs of running a business through a Limited Company. The Company would also need to pay Corporation Tax on its profits before dividends can be distributed.

Setting up a limited company

A limited company is a separate legal entity from its owners (shareholders), meaning limited companies have a higher degree of protection and structure. Let’s take a look at some of the biggest pros and cons: 

The pros:

• Limited liability: One of the most significant advantages of a limited company is limited liability. Your personal assets are separate from the company's finances, and you’ll use a business bank account (rather than your personal one), providing you with protection if the business faces financial difficulties or legal disputes.
• Credibility: Limited companies often appear more credible and trustworthy to potential clients, partners, and investors. This can open doors to bigger contracts and more significant opportunities.
• Tax efficiency: Limited companies often have more options for tax planning and optimisation. You can pay yourself a salary and also receive dividends, potentially leading to lower overall tax payments.
• Access to funding: Limited companies can raise capital by issuing shares to investors, making it easier to secure funding for growth and expansion.

The cons:

• Complexity: Setting up and maintaining a limited company involves a lot more admin (from Annual Accounts and Corporation Tax Returns to the IR35) - and often a lot more costs. You'll need to register with Companies House, set up a new business bank account, and potentially have more accounting responsibilities.
• Less control: Limited companies are often governed by a board of directors and have to adhere to formal decision-making processes. This can mean you lose out on some immediate decision-making control compared to being a sole trader.
• Public disclosure: Financial statements and certain company details are publicly available on Companies House when you're a limited company, which you may find uncomfortable if you value privacy.

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So, which will it be?

Deciding between being a sole trader or setting up a limited company is a pivotal choice that can shape the future of your business. But remember, although it’s a lot of effort, it is possible to change the structure of your business down the line as your preferences and ambitions change and grow. Read our recent article on changing from being a sole trader to running a limited company to find out more. 

Each structure comes with its own set of benefits and challenges, and what works for one person might not be suitable for another. Take your time to evaluate your business's needs, your long-term goals, and the level of protection and control you’re looking for. Always consult a tax advisor or professional accountant to get the guidance you need to make an informed decision that sets your business on the path to success.