Limited company or sole trader – compare business structures

One of the most important decisions you make when you set up a new business is to decide what type of trading structure to use.

There are several less widely used legal structures – such as limited liability partnerships which are often used by accountancy and other professional firms.

However, the vast majority of small business owners work as self-employed (i.e. as ‘sole traders’ or ‘partnerships’), or via their own limited companies.

Please take some time to read the following points to help evaluate which trading structure is best for you.

Scroll down for our handy limited vs self employed comparison table!

Tax Issues

Limited companies, their directors, and the self employed are each taxed in different ways.

Limited company taxes

A limited company has a separate legal entity from its shareholders and directors, whereas the business and personal affairs of self employed people are treated ‘as one’ for tax purposes.

  • Limited companies pay Corporation Tax on their annual profits.
  • Directors and employees pay personal tax on any income they receive from the company.
  • Shareholders pay dividend tax on dividends received from the company.
  • Employees (including directors) pay income tax and NICs if they receive a salary.
  • The company itself pays Class 1 Employers’ NICs on salaries it pays to employees.

Self employed taxes

If you are a sole trader, you pay income tax and Class 2 and 4 national insurance on your annual profits if they are above £12,570.

Your total tax bill is calculated when you fill in your annual tax return. The self assessment deadline for submitting your return and paying any tax due is 31st January each year.

Value Added Tax (VAT) – companies and the self employed

Both companies and sole traders must register for Value Added Tax (VAT) if turnover reaches £85,000 or more per year (2023/24).

You can register for VAT voluntarily before your turnover reaches the VAT registration threshold if you wish to.

There are many benefits to doing so. For example, you can reclaim the VAT on purchases too.

Administration and Costs

Generally speaking, running a limited company is more onerous than being self employed.

As a company director, you also have a number of statutory and financial duties to keep on top of.

Limited company administration

All limited companies are registered with Companies House.

Companies file a Confirmation Statement and PSC each year and file a company of their annual accounts.

You can form a limited company for under £100, so the costs of setting up the business structure itself are minimal.

In reality, the ‘hassle’ involved in being a company director is not significant.

Most companies use an accountant to take care of their tax affairs and deal with Companies House and HMRC.

Self employed administration

There is less paperwork to worry about if you’re self employed, although you must still keep accurate records.

When you first start up your new business, you need to inform HMRC when you become self employed.

You also need to comply with any industry regulations (such as employment laws, health and safety, and discrimination rules).

Sole traders typically employ the services of a bookkeeper or accountant to complete or help with their annual tax returns.

Business structures and credibility

In some industries or professions, you may find it more advantageous to trade via a limited company.

Some business owners find that their customers feel more comfortable dealing with a limited company.

If you are providing professional services (as a consultant, or surveyor, for example), most clients expect you to trade via your own company – in fact, it may be a contractual requirement.

Employment Status

Although you can run most types of business under either type of trading structure, the legal status of each is very different.

Limited company

A limited company is a legal entity in its own right. It has a separate legal status from its directors and shareholders.

If you are a director, you are an officer of the company. In many cases, directors are also employees of their companies.

Even though you are working for yourself, you are not considered ‘self employed’ for tax purposes.

Self employed

As the name suggests, as a self employed person, you cannot also be an ’employee’ of your new business. You are the business.

This means that both you (the individual) and your business share the same legal and tax status.

Business structures and liability

Following on from employment status, your liability also differs between structures if things go wrong.

Limited company liability

A limited company is a separate legal entity. So if something goes wrong, it is the company, not its directors which is held liable.

If your company fails and owes money to creditors,  you will not have to pay the creditors out of your personal assets.

This is unless fraud or other offences have taken place.

The liability of company directors is therefore limited, hence the term ‘limited liability company’.

This is a key advantage that running a business as a limited company has over being a sole trader

Sole trader liability

As a sole trader, you are personally liable if things go wrong. This might happen if your business gets into debt, or faces a legal claim from a client or employee.

If your business goes under, creditors can pursue you for your personal assets if you are self employed.

For these reasons, we always recommend you discuss your business with an accountant before deciding upon the right legal structure to use. You should not rely solely on the information we have provided in this article.

Limited vs. Self employed – a comparison table

Limited CompanySole Trader
Legal StatusA limited company is a separate legal entity from its shareholders and directors.The business and its owner are treated as the same single entity.
TaxationThe company pays Corporation Tax on its profits. Employees (including directors) pay income tax and Employees' NICs on any salary. The company pays Employers' NICs on salaries. Individuals pay dividend tax on any distributions received via the Self-Assessment process.The business and its owner are treated as one entity via the annual Self-Assessment process. The self-employed pay Class 2 and Class 4 NICs, as well as income tax.
Starting UpYou have to incorporate your company, and register the company for various taxes (Corporation Tax, VAT, and as an employer). You will typically hire an accountant to undertake the start-up tasks. Very simple - you can start trading instantly. Just let HMRC know that you've started a business.
LiabilityAs the name suggests, the liability of directors is limited should anything go wrong. If the company becomes insolvent, your personally liability is limited unless you have made a personal guarantee to secure funds.If something goes wrong with the business, its owners are liable. If you go insolvent, you are liable to settle any outstanding debts.
Tax PlanningDirectors can decide when to distribute dividends, and may defer to a future tax year to minimise tax. You may share the business with your spouse to reduce the tax burden.You cannot defer profits. Tax planning options are minimal.
PaperworkMore paperwork than the sole trader route. An accountant will undertake most administrative tasks, although the directors are ultimately responsible for accurate and timely filing. Directors also have a number of general responsibilities they must take on.Very little regular paperwork. You must maintain accurate records.
PrivacyThe details of the company and its directors can be searched on the Companies House database, although you can use a service address instead of your residential address to protect your own privacy.Your details are not displayed or searchable by the public.
Raising MoneyBanks and other financial institutions are more likely to lend to incorporated entities.Harder to raise funds as a sole trader.
Tax EfficiencyIn general, the tax burden is lower for a company director, as no NICs are payable on dividends. You can also offset a number of expenses against the company's tax bill.Overall tax burden is higher compared to the limited company route, as tax and NICs are payable on your entire profits.
PensionsYou can set up an executive pension, which may be more generous than personal schemes. Contributions are paid by the company, and offset against the company's Corporation Tax bill.You can only invest in a personal pension, although tax relief is available.
InvestorsIt is more attractive to would-be investors if you are incorporated - you can offer shares in the business.You cannot offer shares in your business. Instead, you could set up a partnership.
Succession PlanningWhen you die, the company remains - as it is a separate legal entity. When you die, your business will no longer exist.
ImageHaving a limited company may provide its owners with a more professional image. Most small businesses operate as sole traders, but in certain industries you may benefit by incorporating.
Providing personal servicesIf you are a contractor or consultant, you will typically need to incorporate, as most clients will only work on a company to company basis.Most clients will not work with professional contractors if they are self-employed, as they do not want to deal with potential employment claims.
Business nameYour company name is protected, and no other company may use a 'similar' name, according to Companies House rules.Although trademarks are protected regardless of business structure, other businesses may have very similar names to your chosen trading name.
AccountsYou must have your company accounts prepared and submitted to Companies House and HMRC each year. Your accountant will do this on your behalf.You are not required by law to prepare or submit accounts, however, they will be useful - especially when preparing your annual self-assessment return.

Tax-efficient protection for directors

  • limited company life cover