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If you’re looking to work for yourself, then you need to choose between becoming a sole trader or setting up a limited company.

Each has pros and cons.

Tax

Sole trader:

  • you’ll pay Income Tax on what you earn from self-employment minus some allowable expenses
  • if your expenses are not that high or you can’t be bothered with receipts, then claiming the flat £1,000 “trading allowance” is much easier.

If you go the limited company route, then you need to decide how to pay yourself:

  • through a salary: you need to set up a Pay As You Earn (PAYE) scheme for yourself
  • through dividends: remember that before paying dividends your company also has to pay 25% corporation tax
  • or a combination of both.

Winner: limited company, but not by much – mostly because you have more freedom in how you pay yourself and what you can expense.

National Insurance

This is one of the biggest differences.

  • If you’re a sole trader, then you only pay Class 2 and Class 4 NI contributions
  • If you run a limited company, you will pay much more: both the employer’s and employee’s National Insurance on your director salary.

This is why most one-man-band limited company directors prefer to pay themselves only enough salary to qualify for State Pension, and the rest as dividends.

Winner: sole trader.

The tax return process

Sole traders only need to file a Self Assessment tax return once a year:

  • you can try doing it yourself for free
  • or use a tax return service like TaxScouts for just £119.

If you do business through a limited company, then you need to:

  • prepare annual accounts and a company tax return, which you file with HMRC
  • and also file a confirmation statement with Companies House.

Corporation tax returns are much more expensive and you’ll also need to deal with bookkeeping or hire an accountant to do it for you.

Winner: sole trader – by far.

Debts and legal risks

This is another huge difference:

  • If you’re a sole trader, you are your business. Any business debts become your debts and what you own (including your house!) is not protected. However, a good professional indemnity insurance should be sufficient for most sole trades.
  • A limited company can protect you: the loans belong to the company, not you.

Winner: limited company – but only if you need business insurance or a business loan.

Other factors to consider

  • start-up costs: it’s free to register as a sole trader with HMRC (although it’s a bit complicated: TaxScouts can help you register as self-employed for just £25)
  • privacy: limited company directors have to provide their details to Companies House – this info will be public
  • credibility: many companies prefer to do business with other limited companies, or at least with VAT-registered sole traders
  • funding: it’s very difficult to get a business loan as a sole trader.

Switching from one to the other

You can easily do it.

We recommend to start small as a sole trader and, if your business grows, set up a limited company later on.