If you’re planning on going self-employed and running your own business, you’ll run into an early dilemma and ask yourself: ‘should I run my business as a sole trader or a limited company?’

If you haven’t considered this yet, then perhaps you need to know what it means to trade as each of these. You’ll also need to know the advantages and disadvantages of each option so you can decide which legal structure might best suit your business.

Difference between sole traders and limited companies

The main difference between your two main choices can be discerned from their names.

First, a sole trader runs a business that they are solely responsible for. 

Under this legal structure, there is no legal difference between the sole trader and the business. What the business earns, you earn. What it owns, you own. And the money the business owes is money that you owe. 

But this wouldn’t be the case if you owned a limited liability company, as they are legally separate from the owner. In other words, the company director has ‘limited liability’ for the company. 

That’s great news for your personal assets, which will be safe if the company cannot pay its debt.

Sole trader: pros and cons

Being a sole trader is a relatively simple way to run a business, as there is far less administrative work involved than there is for limited companies to deal with.

For instance, there’s less paperwork, fewer registrations and you will only have one tax return to do each financial year – a self-assessment for income tax.

However, because your profits will be taxed with income tax, it does mean you will probably have to cough up more than the director of a limited company, especially if you’re doing particularly well.

Moreover, as we touched on, your assets could be on the line, including your own home, if your business can’t pay its creditors. 

Furthermore, if your business does go bust, you could face personal bankruptcy all all the restrictions that brings.

Limited company: pros and cons

On the other hand, your personal assets will always be safe if your company is the one that owes money. Again, you and your company will be considered as completely separate legal entities.

Limited companies also offer a tax treatment that may allow you to keep more of your cash.

First, your profit will be taxed at a flat rate of 19% in corporation tax, as opposed to the 20%, 40% and 45% income tax brackets a sole trader may have to pay on their profits.

While your personal income will also be taxed when you withdraw it from your company, as a director, you can use some smart thinking to reduce your tax bill.

Many people do this by keeping the salary within the income tax personal allowance (currently £12,570), so they don’t have to pay income tax. We would recommend keeping your salary below £8,840, though, so you don’t have to make employer’s National Insurance contributions.

You can then top up your payments with dividends, which are taxed at a much lower rate than income tax.

However, you will have to contend with extra responsibilities, including, but not limited to, registering with Companies House, submitting corporation tax returns and maintaining statutory records.

Which structure should I choose?

You came here for a straight answer, so let’s give you that.

If you’re just starting out, you should run your business as a sole trader, but be extra careful with your finances. Investing in a quality accountant is one of the best ways to save yourself money down the line.

If your business is turning over more than £30,000 a year, you should consider turning it into a limited company as this is when tax saving starts to significantly outweigh the administrative costs.

However, you should always talk to an accountant before you incorporate your business, just to flesh out the details and make sure it’s the right decision for you.

Talk to us about your business and its legal structure.