Sole Trader or Limited Company? What Changes for Your Tax

The structure you pick changes how you pay tax, what you file each year and how exposed your personal money is if the business struggles. Here is how the two main options compare.

Summary

• Sole traders pay Income Tax and National Insurance on their profits through Self Assessment; limited companies pay Corporation Tax on company profits.
• A sole trader has unlimited liability, so personal assets are at risk if the business owes money; a limited company usually protects what you have put in.
• You must register for Self Assessment as a sole trader if you earn more than £1,000 in a tax year.
• Limited companies file annual accounts with Companies House and a Company Tax Return, even if they make a loss.
• Most businesses start as sole traders, and it is usually easier to move from sole trader to limited company than the other way round.

Choosing between trading as a sole trader and setting up a limited company changes how you pay tax, what you file each year and what happens if debts pile up. Over 3 million people in the UK trade as sole traders, making it the most common structure, while 37% of businesses are limited companies. Here is how the two compare.

What Each Structure Actually Is

A sole trader is a business owned and run by one person. There is no legal difference between you and the business: you make all the decisions and keep all the profits after tax. You can trade under your own name or a business name.

A limited company is a separate legal entity, registered with Companies House. The company, rather than you, can own things, owe money and agree contracts in its own name, and it is run by one or more directors. Here is how the two compare at a glance:

How You Pay Tax

As a sole trader, you pay Income Tax on your profits through Self Assessment. You must register if you earn more than £1,000 in a tax year, which runs from 6 April to 5 April, though you can register earlier. HM Revenue and Customs (HMRC) works out what you owe based on your profits, and you may need to pay National Insurance contributions too.

A limited company pays Corporation Tax on its profits instead, and not at all if the company makes a loss. Profit is what remains after running costs and adjustments for tax. On top of that, you may pay Income Tax on money you take out personally.

Both structures may need to register for VAT if they meet the requirements.

Paperwork and Filing Obligations

The administrative gap is wide. As a sole trader, you register once, keep records from the start of trading and complete a Self Assessment return each year. If you have not filed a return before, our walkthrough of how to file your first Self Assessment tax return covers registration, records and deadlines.

A limited company carries more obligations. You must:

• register with Companies House and pay a fee before you start trading
• choose a company name that meets Companies House rules, plus a registered address that is published online
• get every director and person with significant control to verify their identity
• prepare a memorandum and articles of association and pick Standard Industrial Classification codes
• file annual accounts with Companies House every year and send HMRC a Company Tax Return, even if the company makes a loss or has nothing to pay

Company accounts are on the public record, which matters if you want your finances kept private.

Personal Liability if Things Go Wrong

This is often the deciding difference. Sole traders have unlimited liability, meaning you are personally responsible for all the debts of the business. If the business gets into money trouble, your personal cash and belongings could be at risk, and business insurance may add protection.

With a limited company, liability is limited to the value of your financial investment. If the company runs into trouble, your home, savings and belongings are generally protected; you can only lose what you have put in.

Taking Money Out

Sole traders keep all profits after tax and take drawings from the business. There are no formal rules on how you withdraw money, but everything rests on the profit you report through Self Assessment.

Directors must follow rules when taking money out of a limited company. The main routes are a salary, dividends (a share of the company’s profit) or a directors’ loan. Salary may attract Income Tax and National Insurance, while dividends depend on the company having made profit. Whichever route you use, money you take personally is taxed as income.

Which Structure Suits Whom

A sole trader tends to suit people who want a simple setup, minimal reporting, full control and the ability to start trading straight away. Most people begin this way.

A limited company tends to suit people who want to protect personal assets from business debt, take on investors or apply for business loans, or who expect tax savings to offset the extra admin costs. Some clients also see limited companies as a safer bet when choosing who to hire.

Whichever way you lean, you can change structure later, and it is usually easier to move from sole trader to limited company than the reverse. Either way, a dedicated business bank account makes it easier to separate business and personal finances, and our guide to budgeting for UK household bills shows how to build regular set-asides for lumpy costs, a habit that works for tax bills too.

Next steps

• How to File Your First Self Assessment Tax Return: the practical steps for registering and filing, essential if you choose the sole trader route.
• Budgeting for UK Household Bills: a method for smoothing irregular costs, which works for tax bills too.
• Workplace Pensions and Auto-Enrolment: how pension deductions work if you take a salary from your company.

Questions readers ask