Being a sole trader or a limited company can be a big dilemma for some small businesses. Most businesses will start as a sole trader, but then make the consideration as to whether to become a limited company. There are certain benefits that may be attractive to small businesses that are expanding, and limited companies can be more tax efficient in some cases.
In this article, we outline everything you need to know about being a sole trader or a limited company, and provide the tax rates for both, as well as an example scenario.
Tax rates for a sole trader
Being self-employed means that you will have registered for what is called Self Assessment with HMRC, and are referred to as a sole trader.
As a sole trader, you will pay income tax on all your business profits. The taxation is almost identical to how it would be if you were employed.
Profits under £12,571 you will pay no tax – this is your ‘tax-free allowance’, which is applicable to everyone in the UK.
Remember, if you are a sole trader, and you earn under £12,571, you still need to file a tax return, but won’t then need to pay anything.
Here are the tax rates for a sole trader:
- Profits between £12,571 and £50,270 are taxed at 20%
- Profits between £50,271 and £125,140 are taxed at 40%
- Profits above £125,140 are taxed at 45%
You will also make National Insurance Contributions, which will be included in your return, and are a much smaller amount.
We have a guide on registering as a sole trader if you aren’t sure how to do it.
Tax rates for a limited company
A limited company is more complicated to run, but has benefits for larger organisations. A limited company is an entity in itself, so it is treated like a person.
Any directors of limited companies will make their earnings from dividends, which are payments from holding the stocks within the company. They will also receive a salary, as they are an employee of the company.
If you start a limited company on your own, then you will be the director of the company, but also be paying yourself a salary and earning dividends based on the earnings of the company. For this reason, limited companies can in some cases be slightly more tax efficient, even though they may be significantly more complicated.
Corporation tax
A limited company must pay corporation tax, and any dividends are also taxed, but both at a smaller rate.
Here are the tax rates for corporation tax in a limited company:
- Profits between £50,000 and £250,000 are taxed at 19%
- Profits above £250,000 are taxed at 25%
There is also what is known as a ‘sliding scale’ where the rate of the tax will vary depending on the size and structure of the company. There are also certain relief clauses, for example any ring fence companies.
Dividend tax
Just like your £12,571 tax-free allowance, you also have a £1,000 dividend allowance which is tax free.
The tax rates for dividends are as follows:
- Profits between £12,571 and £50,270 are taxed at 8.75%
- Profits between £50,271 and £125,140 are taxed at 33.75%
- Profits over £125,140 are taxed at 39.35%
Directors of companies will often take both a salary and dividends, to reduce their overall tax contributions.
Benefits of being a sole trader
The main benefits of being a sole trader are the simplicity and the ease of starting and stopping it. You can register for Self Assessment on the Gov.uk website, and simply notify HMRC if you are no longer self-employed.
Simpler to set up & run
Being a sole trader is far simpler to set up and run. All you need to do is apply for Self Assessment, and then file a tax return each year in January of the following year. You will be prompted by HMRC on all the deadlines, and given a SA100 tax return form to fill out.
Limited companies are much more complicated to run, which can potentially incur further costs, particularly if tax returns are filled out incorrectly or submitted late.
Companies will often hire an accountant or tax advisor simply to deal with the complications, which is a cost in itself.
Privacy
Being a sole trader, your details are private. However, all limited companies are required to have their information public, such as where the company is based, and the names and addresses of directors. This means that if you are running a business from home, you may need to have your name and address on the public register.
There are ‘virtual office’ services available, if you are looking to submit an address which is not your own and keep your home address private.
Benefits of being a limited company
The benefits of being a limited company mainly come down to greater tax relief and appearing more legitimate, with stronger processes in place when it comes to working with other businesses and potential partners.
Tax advantage
Although it is more complicated, a limited company will likely pay less tax overall than a sole trader. As you can take pay as dividends and salary at your discretion, you can adapt your earnings to be more tax efficient.
Furthermore, sole traders only have personal pensions, that also must be declared as income, whereas a limited company can contribute to a director’s pension, which can be then claimed as a business expense.
You can also avoid National Insurance Contributions (NICs) if you pay yourself below the minimum salary threshold of £12,571.
Limited liability
A limited company is by nature ‘limited’ in its liability, meaning that it operates as a legal entity. This means that in the eyes of the law, your company is a separate entity to you.
For example, you were to be sued, the company would be liable for the damages, and the claimant would be suing the company, not you. This means that the company accounts and the
However, if you were to be sued as a sole trader, you are entirely liable for all the costs and damages, which means that anything in your name could potentially be collateral. The claimant would be taking you as an individual to court, and you have far fewer protections.
Credibility & status
All large companies become limited companies eventually as this is how best to structure them, particularly when it comes to hiring employees, working with other businesses, and taking on shareholders.
Setting up as a limited company can be one of the best ways to position your business as a more serious venture. Some companies could be put off by trading with sole traders, as they are technically working with an individual, who could be entitled to rights and benefits of the company, whereas a limited company will always handle their own legal compliance.
Partners, selling & investment
Later down the line, you might be interested in selling your business, or bringing on partners to help you run the business. As a sole trader, the business is only you as an individual, so you won’t be able to hire officially – they also need to be sole traders themselves, so there is no legal bond between you.
With a limited company, a partner can be brought in as a director and shareholder, meaning that they have a legitimate. stake within the business
When it comes to a sale, anyone looking to buy may have difficulty in the purchase if you are a sole trader. There will technically be nothing tangible from a legal sense that they can buy, but as a limited company is a legal entity, the purchase of the business can be much smoother.
Is it better to be a sole trader or a limited company?
This question depends entirely on your financial situation and the size of your company.
If it is just you within the business, and you earn a small amount, for example, under £50,000 per year from your business, then setting up as a sole trader is likely the best option.
However, if you earn £200,000 from your business, and have people working for you, then setting up as a limited company might be a better option.
Theoretically, you can stay a sole trader forever, regardless of your income and company size. However, it makes far more sense to become a limited company, and will make hiring employees much easier and tax efficient if you are a limited company.
Remember, you can be self employed and have a limited company, so the best move could be to set up as a sole trader first, and then incorporate your limited company at a later date.
As always, make sure to do due diligence, and if you are unsure, speak to a financial advisor who will be able to help you.
Do you pay more tax as self-employed or as a LTD company?
Limited companies will likely pay less tax, but then this all depends on the size of your company.
Let’s take an example of earning £45,000 as a sole trader and a limited company.
£45,000 as a sole trader
If you earned £45,000 per year, and were registered as a sole trader, here is what your take home would be in the 2024/25 tax year:
- Tax-free allowance: £45,000 – £12,570 = £32,430
- 20% income tax: £32,430 × 20% = £6,486
- Class 2 National insurance contributions: £179
- Class 4 National Insurance Contributions (9%): £32,430 × 9% = £2,918.70
Total tax and National Insurance Contributions: £6,486 + £179 + £2,918.70 = £9,583.70
From earning £45,000 as a sole trader, your take home pay would be £35,416.30.
£45,000 as a limited company
If you earned £45,000 per year, and were registered as a limited company, here is what your take home would be in the 2024/25 tax year:
- Tax-free allowance (taken as a salary): £45,000 – £12,570 = £32,430
- 19% corporation tax: £32,430 x 19% = £6,161.70
- Dividend Allowance: £1,000 tax-free
- 8.75% Dividend tax: £25,268.30 × 8.75% = £2,209.48
This means your earnings will be a salary of £12,570 plus dividend payments after tax of £24,058.82.
From earning £45,000 as a limited company, your take home pay would be £36,628.82
Finding a balance
So the difference between the two is that being a limited company in this hypothetical situation would have saved you £1,212.52.
However, this all depends on the size of the business, employees and when you start your business, as you can fall into different tax years.
The difference is often marginal, and it could be that you end up paying more as a limited company, as you could end up paying more for administrative costs, and also just sinking a lot more of your time into the tax process. Remember there are also penalties for late and incorrect filings.
The best thing to do is speak to an accountant or tax advisor and receive professional advice on what the best option might be for your specific business.
Can I be self-employed and employed at the same time?
Yes, this is entirely possible.
Your earnings will essentially be combined into one amount, which you are then taxed on.
For example, if you were earning £30,000 per year as a salary, under a PAYE contract, and then earned £20,000 as a sole trader, you would be taxed the same as if you were earning a £50,000 salary.
Your Self Assessment tax return will ask you about any other streams of income, and it will be here where you state your current earnings, which will then affect how much tax you pay.
This won’t affect the salary or tax payments from your current employer. However, on a professional level, make sure that you have notified your boss about your earnings on the side, as many employee contracts state that a certain amount of hours and dedication must be put into the job.
Conclusion
Setting up as a sole trader or a limited company can be a complicated decision, but hopefully from this article, you have a better idea of what the advantages and disadvantages are of both.
Small businesses are often hit the hardest by tax and costs. VAT can often be a tough tax for both sole traders and limited companies, as once a business of either kind surpasses £90,000 per year, then you must register for VAT.
We have VAT loans at Rise Funding which can help you with your tax bill and reduce the impact of costly late payment fines.
If you are looking for any other type of funding for your business, then feel free to use our Instant Quote tool to find the funding that works for you.
