If you are planning to start a business in the United Kingdom, you will undoubtedly face a choice of business structures. In most cases, you will need to choose between doing business as a self-employed or a limited company.

Depending on the specifics of your business, either of these two structures can be more advantageous than the other. Read on to learn about the pros and cons of these two common legal structures and decide which is best for you.

What is better: Being a sole trader or operating as a limited company?

When deciding whether to register as a limited company or as a sole trader in the UK, there are a few factors to consider, and we are going to take a deeper look at the main things you need to consider.

Business ownership & control

It is important to decide whether you will be a single business owner or a co-owner to ensure your structure is legally compliant. A sole trader status implies sole business ownership, while a limited company can be run by one or more individuals.

Admin & reporting duties

These business structures are also subject to different reporting requirements, which determine the amount of time you will need to spend on administrative tasks. In general, sole traders spend less time on paperwork than limited companies because it is a much simpler business structure.

Access to finance, loans and investment

Access to finance can vary significantly depending on whether you operate as a sole trader or a limited company.

Sole traders often rely on personal credit, overdrafts or unsecured loans, as lenders see the business and the individual as the same entity, limiting borrowing options and putting personal assets at risk.

Limited companies are generally viewed as more established and transparent, making it easier to access business loans, asset finance and investment. They can raise funds by issuing shares and are often more attractive to external investors. Clear financial records and company accounts also help lenders assess risk. In practice, limited companies usually have more structured and scalable financing options as they grow.

Business credibility

For some industries, the legal structure of a business may play an important role in terms of credibility, where clients may perceive one business structure as more credible than another. For example, some corporate clients are more likely to hire a legal professional who provides services as a limited company rather than a sole trader.

Business losses

Business losses are treated very differently depending on whether you operate as a sole trader or through a limited company, and this can have a big impact on your personal tax position.

If you’re a sole trader, business losses can often be offset against your other income, such as employment salary, in the same tax year or the previous year, resulting in a tax reduction when submitting your tax returns, something which can be extremely helpful in the early stages of a business. Alternatively, losses can be carried forward and used to reduce future profits from the same trade.

For limited companies, losses belong to the company, not the individual. This means that they can’t be offset against your personal income, but instead, company losses are usually carried forward to reduce future Corporation Tax bills, or in some cases, carried back to reclaim Corporation Tax paid in previous years.

Sole traders have more flexibility to use losses for immediate personal tax relief, while limited companies use losses to support longer-term business tax planning.

Legal disputes and personal liability

The difference between how legal disputes are handled when you’re a sole trader or a limited company can be significant.

If you’re a sole trader, there is no legal separation between you and your business, which means that if a dispute arises—for example, a client claim, unpaid debt or contractual disagreement—you are personally responsible. Any legal action is taken against you as an individual, as well as your personal assets such as savings or property, putting them at risk if the claim is successful.

With a limited company, the business is a separate legal entity, with legal disputes generally brought against the company itself rather than the directors or shareholders personally. This provides an extra layer of protection, as liability is usually limited to the company’s assets. However, directors can still be held personally liable in certain situations, such as wrongful trading, fraud or where personal guarantees have been given.

Please note that this content is for general information only and does not constitute legal advice. You should always seek professional legal advice for your specific circumstances.

Taking money out of the business

The most tax-efficient way to take money out of a business depends on your business’s legal structure. For sole traders, there is no real choice — all profits belong to you personally and are taxed as income, regardless of how much money you actually withdraw. This can make tax planning more limited as profits increase.

For limited companies, there is far more flexibility, with company owners able to reduce their overall tax bill by paying themselves through a combination of salary and dividends. A modest salary can make use of the personal allowance and maintain National Insurance records, while dividends are taxed at lower rates and are not subject to National Insurance. This approach allows profits to be withdrawn more efficiently and, if needed, retained in the business for future growth.

Company owners can also take advantage of Benefits in Kind (BiK), for example, a company car, private medical insurance or other non-cash benefits.

BiK are subject to unique tax rules and may be treated as taxable income, but they often reduce the cost of paying out of pocket for these benefits.

Please note that this content is for general guidance only, and you should always seek professional tax or accounting advice before deciding how to take money out of your business.

Pension planning for business owners

Pension planning looks very different depending on whether you are a sole trader or you operate through a limited company.

For a sole trader, pension contributions are usually made personally into a private pension, such as a personal pension. Contributions receive tax relief at your marginal rate, meaning basic-rate tax relief is added automatically and higher-rate relief can be claimed through your tax return. However, contributions are made from your taxed income, which can limit how much you’re able to invest.

For limited company directors, pension planning is often more flexible and tax-efficient. The company can make employer pension contributions directly into a director’s pension scheme, and these payments are treated as a business expense, reducing Corporation Tax, and are not subject to Income Tax or National Insurance for the individual. This makes pensions a powerful way to extract value from the company while planning for the long term.

Please note that annual allowance limits still apply to both structures, and pension rules can change. This content is for general information only. You should always seek regulated financial advice before making pension decisions.

Choosing a business structure: The key differences between a sole trader and a limited company in the UK

‘Should I register as a sole trader or form a limited company’ is one of the more common questions in the UK from people looking to start a new business. Let’s look at the pros and cons of both legal structures.

First, it is in your best interest as a business owner to keep the reporting process as simple as possible. From this point of view, setting up as a sole trader is more advantageous.

However, it’s not that simple as sole traders face a lot of restrictions that limit their fiscal flexibility. For example, they can’t claim some expenses that a limited company can.

Also, as a sole trader, you are the one responsible for the debts associated with your business activity, unlike a limited company, where the assets of a business owner are separated from those of the business and are protected.

You have to be aware of some important things to make the best decision between being a sole trader or a limited company

The main differences between a limited company and a sole trader

Limited company

Owned by one or more people.
19% corporation tax + dividend tax, if any, is received + income tax on employees, if any.
The business owner has the advantage of limited liability.
Has more strict reporting requirements and involves more paperwork—reports to HMRC and Companies House.

Sole trader

Owned by a single person.
20% to 45% income tax on income over the Personal Allowance threshold + national insurance contribution if your income exceeds £6,515 per year.
The business owner is liable for the business’s debts.
Easier in terms of reporting. Reports to HMRC.

Sole trader vs. limited company tax rules

Tax rules are different for sole traders and limited companies. While the primary type of tax paid by a limited company is 19% corporation tax, sole traders pay income tax, and that tax rate depends on their income, varying from 20 to 45%.

Since the tax rate for sole traders grows proportionally with their profit, there is a certain point at which it is more beneficial for sole traders in the UK to switch to a limited company structure. There’s no clearly defined annual income at which point you should switch to a limited company, but typically it’s worth seriously considering (or seeking professional advice) when your business profit consistently exceeds £30,000-40,000 per year.

For this reason, the difference in tax rates is the most common factor that makes sole traders switch to a limited company structure.

Is it better to be self-employed or a limited company? Which one is right for you?

A sole trader status is an attractive option for many freelancers looking to take control of their careers. It gives them the freedom to work from home or anywhere with an internet connection and the flexibility to set their own hours. It entails less administrative work and a simpler reporting process. Put simply, it’s easier to get started.

However, a sole trader is not entitled to some employment rights, such as maternity/paternity leave, a minimum wage or paid holidays. However, they can still claim some tax benefits and may be able to register for certain other benefits. Another downside of the sole trader status is that it can be more challenging to get a loan, as banks will often require a personal guarantee when lending money.

There is also such a factor as credibility. A limited company will often be perceived as more credible than a sole trader.

However, one of the most important factors when deciding to register as a sole trader or a limited company is taxes. As mentioned above, once you reach a certain profit level, it may become more advantageous for you to operate as a limited company.

Here are a few common reasons why people choose to switch from being a sole trader to becoming a director of their own limited company:

Their income grows to the point where it’s more beneficial for them to pay taxes as a limited company rather than as a sole trader.
They plan to sell their business, as it is easier to sell a business as a limited company.
They want to raise capital by taking out a loan or attracting investors.

Generally, changing a business structure from sole trader to a limited company is an easy process. To set up a limited company online, a business owner must complete a few steps:

In order to switch from being a sole trader to a limited company, notify HMRC about a change in legal structure.

Note that you will still need to complete your self-assessment tax return as a sole trader by January of the following year.

Transfer your business assets to your new company and change your company address if needed.
Set up a bank account for your new business (even if you have a separate account for your sole trader business, you still need to set up a new account for your limited company)
Inform your employees, contractors, banks, lenders, clients, etc., about the change of business structure and your new business bank details.
Register your company for taxes: corporation tax, PAYE, and VAT, if applicable.

One of the most common difficulties that the owner faces when changing a legal structure is failing to complete any of the steps described above. After the transition is complete, it is crucial to be aware of and fulfil the new legal responsibilities and reporting requirements.

In a nutshell, small businesses tend to choose the sole trader status, as it is the easiest and cheapest way to register a business. It involves less administrative hassle and an easier process of withdrawing money. Conversely, larger businesses decide to register as a limited company to enjoy limited liability and, at a certain profit level, lower taxes.

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FAQ

How do I know whether I should be self-employed or a limited company?

When choosing a business structure, you should consider the following factors: your income as a business entity and tax rate, the amount of admin work you are ready to perform, the credibility your business requires for good performance, and much more.

Do you pay more tax as a sole trader or a limited company?

Limited companies and sole traders are taxed differently. The amount of money you make affects your business's tax rate and becomes the primary decision point in choosing a legal structure, but a limited company is often more tax-efficient for higher earners because you can pay yourself a proportion of your income in dividends, which is taxed at a lower rate compared to a PAYE salary.

Am I self-employed if I have a limited company?

If you run a limited company, you are generally not considered to be self-employed for tax purposes, but instead an employee and officeholder of the separate legal entity (your company).