Sole trader v limited company: saving tax and other key considerations

Register as a sole trader or set up a limited company? It’s a key question to answer when you decide to take the plunge and start your own business because your decision can have major implications.

And even after making a choice, with your business firmly established, every once in a while, you should crunch the numbers to work out whether the legal form you chose is still the right one for you and your business, whether that’s sole trader or limited company. We spoke to our friends at GoSimpleTax to get some insight into this topic before you make your decision.

Sole trader v limited company: what’s more common?

• When people “go self-employed” or start their own business in the UK, most become sole traders. It’s by far the most popular small business legal structure. Sole traders make up more than half (56%) of the UK’s 5.5m small-business population, which amounts to about 3.2m businesses.
• In addition, there are some 384,000 (7%) ordinary/general business partnerships, which (tax-wise) is like being a sole trader, but you run a business and share responsibility with a partner or partners.
• Others choose to “incorporate” (i.e. register) a private limited company and there are about two million (37%) of them in the UK.
• Whether you become a sole trader, ordinary business partnership member or set up a limited company, it’s remarkably quick, easy and no cost or low cost. All can be done online via the government website GOV.UK.

Sole trader v limited company: personal financial risk

A major reason why people set up a limited company concerns personal financial risk. As the name suggests, your personal financial liability is limited, provided that you don’t trade recklessly or fraudulently or give personal guarantees for company loans. That’s because, in law, the limited company is a separate legal entity to its owner(s).

The opposite is true for sole trader businesses. In law, there’s no distinction between you and your sole trader business, so you are personally liable for your business debts. That liability is unlimited, which can mean you’re forced to sell off things you own to pay off your business debts, including your car and home. This is less of a consideration if your business is unlikely to build up considerable debts.

Sole trader v limited company: customers and staff

Will potential or existing customers care if you run a sole trader business or limited company. Probably not, because being a limited company is no guarantee that your business is more stable, reliable or superior in any way. And being a sole trader is unlikely to prevent you from being able to tender for contracts, either.

Just because you set up your business on your own, doesn’t mean you’ll have to work on your own. Sole traders can employ others and many won’t care whether you’re a limited company or sole trader, because it has no bearing over how much you pay them or how you’ll treat them.

Sole trader v limited company: finance and tax admin

In many cases, accessing finance and funding won’t be any easier because you run a limited company rather than a sole trader business. Having a sound business plan can be much more important. 

Running a limited company involves much more tax admin when compared to running a sole trader business, which is far simpler. You may be able to do some yourself, although with limited company admin, there’s more of it and it’s much more complicated. 

You could pay an accountant to take care of your tax admin, of course, but if you’re operating a limited company, your fees are likely to be significantly higher, because an accountant will need to do more work for you. To save money, many sole traders do all of their own tax admin, including completing and filing their own tax returns, which is made much easier by technology.

How are sole traders and limited companies taxed?

As a sole trader, you’re taxed on your net profits (i.e. actual profit once all costs have been deducted). HMRC allows you to deduct many expenses and costs from your sole trader income and once any tax allowances have been accounted for and your other taxable income factored in, HMRC will tell you how much tax you owe.

You provide summaries of your sole trader income and expenses to HMRC via your SA100 tax return and SA103 supplementary page (hence “Self Assessment”).

You’re taxed according to the income tax band into which your total annual taxable income falls. You do not pay income tax on your first £12,570 of gross (i.e. total) taxable annual income, because this is your tax-free personal allowance. Thereafter: 

• you’ll pay the basic rate of income tax (20%) if your total annual taxable income is between £12,571 and £50,270
• the higher rate of income tax (40%) if your total annual taxable income is between £50,271 and £125,140 or
• the additional rate of income tax (45%) if your total annual taxable income is more than £125,140.
• 2023/24 tax year for all figures quoted above. Income tax bands and rates are slightly different in Scotland.

The personal allowance decreases by £1 for every £2 of income over £100,000 and if your income is £125,140 or more, you don’t get any personal allowance. If you don’t claim any allowable expenses, you can claim the £1,000 tax-free trading allowance.

Limited companies pay corporation tax on their profits (19% for 2023/24 tax year), while income tax and national insurance contributions (NICs) may be payable on salary the limited company pays you, with tax also payable on share dividend payments that you receive (8.75% if you’re a basic income tax payer; 33.75% if you’re a higher rate income tax payer; and 39.35% if you’re an additional rate income tax payer – all get a £1,000 tax-free dividend allowance).

Sole trader v limited company: which is more tax-efficient?

There’s a popular perception that operating as a limited company means you’ll pay less tax than if you were a sole trader. In some cases, with certain amounts of taxable profit, it’s true – but certainly not in all cases. And tax changes introduced in April 2023 mean the tax advantages of limited company structure are significantly less than they were.

Let’s look at some examples, to compare your take-home if you were a sole trader against your take-home as the sole owner (shareholder) of a limited company.

*All figures calculated by GoSimpleTax, based on 2023/24 tax year figures, and one limited company director and owner (shareholder) taking £9,100 a year as salary and the rest as share dividends, to minimise their tax liability.

At the lower and higher end of the profit scale, based on the above examples, operating a sole trader could give you a greater take-home, while you could also save money by doing your own tax admin.

However, even where your take-home as a company owner is higher, much if not all of that can be wiped out if you have to pay an accountant to take care of your company and personal tax admin. Your monthly fee to an accountant could be, say, between £60 and £120 or more a month (i.e. £720 up to £1,440 or more a year), so operating as a limited company could in fact be less cost-efficient, not more.

How to switch from limited company to sole trader

It’s reasonably simple to change from a limited company to sole trader. You can either close down the limited company completely or make it dormant (i.e. the company still exists but doesn’t trade or receive income from other sources, however Companies House fees and other costs may still apply).

• To close a limited company, usually you need the agreement of its directors and shareholders (easy if it’s just you).
• If your company is “solvent” (i.e. has enough cash to pay its bills/debts), you fill out the DS01 form to apply to Companies House to get the company struck off the Register of Companies (£8 fee for online filing) or you can action a members’ voluntary liquidation. Your company accounts and tax returns must be up to date.
• When you liquidate a company, its assets are used to pay any debts. Any money left goes to shareholders.
• If the company is insolvent (i.e. can’t pay its bills/debts), you’ll need to liquidate it or apply for a company voluntary arrangement, so you can pay creditors over an agreed fixed period. Visit government website GOV.UK for more information about closing a limited company.
• With the company now closed down or dormant, all you’ll need to do is to register as a sole trader for Self Assessment.

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This article was created 26th October 2023

Please note, the content in this article has been provided by GoSimpleTax Limited and is not guidance from Cashplus Bank. Please note, Cashplus Bank makes no representations or warranties of any kind, explicit or implied with respect to the contents of this article. Without limitation, Cashplus Bank does not give legal or tax advice and specifically excludes and disclaims all express or implied warranties and conditions to the fullest extent permitted by law, and any action taken using such content is strictly at the user’s risk.