Starting a business is exciting – but one of the first big decisions you’ll face is your business structure. Should you operate as a sole trader or set up a limited company?
The right choice can affect:
- How much tax you pay
- Your personal liability
- The paperwork you need to manage
- How professional your business appears
It’s a choice a lot of people rush through but the structure you pick can affect all aspects of how your business operates day-to-day, from how it is perceived to daily administration.
Getting it right early can save you time, money, and stress.
In this guide, we’ll break down the key differences, show practical examples, and help you decide what’s best for your situation.
Sole Trader: Simple, Flexible, and Fast to Start
As a sole trader, you and your business are one. There’s no legal separation, which means all income, profits, and debts are treated as your personal responsibility.
This also means you have complete control over decisions and finances, but any risks or liabilities fall directly on you.
Sole Trader Pros and Cons – Why it works for many new businesses
Operating as a sole trader is simple, flexible, and quick to set up, with minimal paperwork and full control over your business.
However, you carry unlimited personal liability, pay tax on all profits, and may face increasing admin requirements with Making Tax Digital.
It’s ideal for small, low-risk businesses or freelancers, but less suitable if profits rise or you want to limit personal risk.
Sole trader tax example
A sole trader earning £30,000 in a year would pay income tax and National Insurance on the full profit, even if some of that money is kept in the business. After tax and Class 2 & Class 4 National Insurance contributions, the take-home income would be approximately £25,288.80.
This illustrates how sole traders are taxed on all profits regardless of whether they withdraw the money for personal use or leave it in the business.
Pros of being a Sole Trader
- Easy setup: Register with HMRC and you’re ready to trade.
- Minimal paperwork: There’s minimal paperwork but make sure you register as a Sole Trader with HMRC to complete your Annual Self-Assessment tax return.
- Flexibility: Ideal for freelancers, contractors, side-hustlers, or testing a new business idea.
- Full control: You make all decisions.
Cons of being a Sole Trader
- Unlimited personal liability: You’re personally responsible for debts.
- Tax on all profits: Even if you leave money in the business.
- Perception: Some clients or lenders may see sole traders as less established.
- Increasing admin: With Making Tax Digital for Income Tax Self Assessment (MTD for ITSA), quarterly reporting will become mandatory.
Upcoming changes that may affect sole traders
With the introduction of Making Tax Digital for Income Tax Self Assessment (MTD for ITSA), sole traders will soon face more frequent reporting requirements. Instead of submitting one annual tax return, you’ll need to send quarterly updates to HMRC, along with a final end-of-year submission.
This means more admin and a greater need for digital record-keeping software – something limited companies are already used to with their existing reporting obligations.
Remember as a Sole Trader, you pay tax on what you make, not what you take.
Remember as a Sole Trader, you pay tax on what you make, not what you take.
-Clare Gunnell – Palmers Accounting
Limited Company: Protection and Tax Planning Options
A limited company, on the other hand, is a separate legal entity, which means the business exists independently of its owners.
Your personal assets are generally protected if the company incurs debts or faces legal claims, giving you limited liability. Operating as a limited company also opens up more flexible tax planning options, allows you to pay yourself through a combination of salary and dividends, and can enhance your professional credibility with clients, suppliers, and investors.
Limited Company Pros and Cons – Why it works for many new businesses
Operating as a limited company provides limited liability, meaning your personal assets are generally protected if the business runs into debt or legal issues. You also gain more tax planning flexibility, the ability to pay yourself through a combination of salary and dividends, and increased professional credibility with clients, suppliers, and investors.
However, a limited company involves more administration, including annual accounts, confirmation statements, and payroll if you pay salaries. Accounting costs are typically higher, and setting up the company requires formal incorporation with Companies House, including recent digital ID verification for directors.
Setting up as a limited company is ideal for businesses that:
- expect growing profits,
- want to reduce personal risk,
- are building a brand,
- or are starting with multiple owners / directors..
For smaller, low-profit, or low-risk businesses, the extra admin may not be necessary initially.
Limited Company Tax Example
A limited company earning £30,000 in profit could pay the director a combination of salary and dividends to reduce personal tax.
For instance, paying a £12,570 tax-free salary and the remainder as dividends taxed at 8.75% (basic rate) would leave approximately £28,518 take-home. But don’t forget the business owner will have already paid a minimum of 19% Corporation Tax on profits so take home pay alone is not the full picture.
Pros of a Limited Company
- Limited personal liability: The company takes the risk – not you.
- Tax efficiency: Pay yourself through salary + dividends. Often reduces overall tax once profits grow.
- Professional credibility: More appealing to clients, suppliers, and investors.
- Structured ownership: Useful if you have partners, want to issue shares, or attract investment.
Cons of a Limited Company
- More administration: Annual accounts, confirmation statements, payroll if paying a salary.
- Higher accounting costs compared to a sole trader.
- Slightly more complex setup: Incorporation with Companies House is required, including a recent digital ID verification process for company directors.
Upcoming Changes and Considerations for Limited Companies
Limited companies already have ongoing reporting obligations, including annual accounts, a confirmation statement, and payroll filings if directors or employees are paid. Recently, Companies House introduced a digital ID verification process for directors, which must be completed online before the company can be officially registered, adding an extra step to ensure security and compliance.
Looking ahead, the introduction of Making Tax Digital for Corporation Tax (MTD for CT) will require companies to maintain digital records and submit quarterly updates to HMRC, rather than relying solely on the annual return. While this increases administrative requirements, it also provides directors with better visibility and control over cash flow, tax liabilities, and profits throughout the year.
A ltd company means lower liability, tax efficiency and separate entity
-Clare Gunnell – Palmers Accounting
Sole Trader vs Limited Company: Practical Comparison
| Feature | Sole Trader | Limited Company |
| Legal entity | You and the business are the same | Separate legal entity |
| Personal liability | Unlimited | Limited to company assets |
| Tax treatment | Income taxed through Self-Assessment | Salary + dividends, potentially lower tax |
| Paperwork | Annual Self-Assessment only | Annual accounts, confirmation statement, payroll |
| Perception | Simple, informal | Professional, credible |
How to Decide: Sole Trader vs Limited Company
Choosing the right business structure depends on your goals, risk tolerance, and the way you plan to run your business. There’s no one-size-fits-all answer, but asking yourself the right questions can make the decision clearer.
Questions to consider:
1.Are you starting the business alone or with others?
If you’re launching with one or more partners, a limited company provides a formal structure to define ownership through shares, outline responsibilities, and protect each partner’s interests. It also makes it easier to split profits fairly, bring in new owners, or attract future investment. Sole traders can only have one owner, so this option isn’t available.
2. Do you expect profits to grow quickly?
Sole traders pay tax on all profits, even if money stays in the business. If you anticipate rising profits, a limited company can be more tax-efficient, allowing you to take a mix of salary and dividends.
For small profits, remaining a sole trader is often simpler and perfectly acceptable. The tax advantages of a limited company are often nuanced by the circumstances of the business owner and only start to outweigh the extra administration once profits rise above £50k per year; there’s no one-size fits all when it comes to tax!.
3. Are you comfortable with personal risk and liability?
Sole traders carry unlimited personal liability. If your business runs into debt or legal issues, your personal assets are at risk. A limited company limits this exposure to the company’s assets.
4. Do you have other full-time employment or commitments?
Sole trading can be simpler for those balancing a business with another job, as there’s minimal admin and flexible hours. A limited company requires more consistent administration and reporting.
5. How important is credibility and perception to your business?
A limited company can appear more professional to clients, suppliers, and investors. Sole traders may be perceived as smaller or less formal, which could affect certain opportunities.
Quick Answers
Choose Sole Trader if:
- Your business is small, simple, or low-risk
- You want fast, flexible setup
- Profits are expected to be modest initially, such as below £50k per year.
Choose a Limited Company if:
- Profits are growing or expected to rise
- You want to reduce personal risk
- You want more tax-efficient pay options
- You’re growing, hiring, or building a brand
- You’re starting the business with one or more partners
There’s no one-size-fits-all answer. Your choice depends on your goals, income, and risk profile.
Still Unsure? We Can Help
If you’d like to explore what’s right for your situation, we can help!
We can provide personalised advice before you register, so drop us a message or book a chat with our team – we’re happy to help you choose the right structure from day one.
FREE VIDEO – How to assess key business drivers
Learn how to review essential metrics from your profit and loss statement to help you keep your finger on the pulse of your business.
Limted Company or Sole Trader – Frequently Asked Questions
What is Personal Liability?
Personal liability means you are personally responsible for your business debts. Sole traders face unlimited liability, while limited companies protect personal assets.
Is it cheaper to operate as a sole trader or a limited company?
At low profits, sole traders may pay less tax. As profits rise, a limited company can be more tax-efficient due to salary + dividend structures.
Sole Trader:
All profits of the business are treated as your personal income.
You pay Income Tax on the profit according to personal tax rates (20% basic, 40% higher, etc.) and National Insurance Contributions (Class 2 & 4).
It doesn’t matter whether you leave money in the business or withdraw it — the tax applies to all profits.
Limited Company:
The company itself pays Corporation Tax (currently 25% on profits over £250k; 19% for smaller profits).
You, as director/shareholder, pay tax only on what you withdraw: a salary and/or dividends.
This allows you to control your personal tax exposure and often pay less tax overall than a sole trader once profits grow above a certain threshold.
Is it best to remain a sole trader at lower profits?
If profits are modest (e.g., under £50k), a sole trader is usually simpler and sometimes slightly cheaper.
This is because:
There’s no need for company administration, payroll, or accounts, which cost time and money.
The total tax payable may be similar to a limited company when profits are low — you aren’t “missing out” on efficiency.
When does a limited company become more tax-efficient?
The tax advantage of a limited company starts to outweigh the extra administration once profits rise above around £50k per year, where salary plus dividends can reduce personal tax.
This works because:
You can pay yourself a tax-free salary up to the personal allowance (£12,570 in 2025/26).
Additional profits can be taken as dividends, which are taxed at lower rates (8.75% basic, 33.75% higher).
The gap grows as profits increase.
So the tax benefit begins when your profits are large enough that splitting salary + dividends reduces your tax and costs like directors pension contributions can be offset against Corporation Tax.
It’s important to remember that tax benefits are not the only advantage of operating as a limited company.
How do dividends work?
What most people don’t realise, and what AI typically gets wrong, is that you can only take dividends from retained profits, which means you will have had to already pay a minimum of 19% Corporation Tax before paying any personal tax. What does mean?
It means that when operating on a limited company basis, the tax planning is far more nuanced around personal circumstances. For example, it is possible when the circumstances are in place for limited company owners have their spouse as a shareholder and split the dividends, which means you’re using two personal allowances.
At Palmers, one of our strengths is in helping our clients match their personal circumstances to their best opportunities for optimisations.
What paperwork does a sole trader need to file?
Sole traders submit an annual Self-Assessment tax return to HMRC. MTD will require quarterly digital reporting in the near future. This will be phased depending on turnover levels from April 2026.
What paperwork does a limited company need?
Ltd companies file annual accounts, a confirmation statement, and run payroll if paying salaries.
Does a limited company look more professional?
Yes. Many clients, suppliers, and investors perceive Ltd companies as more established and credible.
Can I switch from sole trader to limited company later?
Yes. Many businesses start as sole traders and incorporate once profits or growth make it worthwhile.
