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Sole Trader vs Limited Company: Which Is Right for You?
- Jessica Barnett
- Apr 11
- 10 min read
One of the first and most important decisions you'll make as a self-employed person in the UK is how to structure your business. Should you operate as a sole trader, or set up a limited company? It's a question we're asked regularly at Barnett & Co by contractors, freelancers, and small business owners across Crewe and Cheshire — and the honest answer is that it depends on your income, your plans, and your appetite for admin.
This guide breaks down both options clearly, so you can make an informed decision — or at least walk into a conversation with your accountant knowing the right questions to ask.
IN THIS GUIDE
1. What Is a Sole Trader?
A sole trader is the simplest business structure available in the UK. When you operate as a sole trader, you and your business are legally the same entity. There's no registration with Companies House, no annual accounts to file publicly, and no separate business tax return — just a Self Assessment tax return each year.
You register with HMRC, keep records of your income and expenses, and pay Income Tax and National Insurance contributions on your profits. The tax year runs from 6 April to 5 April, and your return and any tax owed are due by 31 January following the end of that tax year.
Sole trader status suits a wide range of people: freelancers starting out, tradespeople, consultants with multiple clients, and anyone who wants to keep things simple while testing whether self-employment works for them.
The main drawback is unlimited personal liability. If your business runs into debt or faces a legal claim, your personal assets — including your home — are at risk. There's also a ceiling on tax efficiency: all profits are subject to Income Tax and National Insurance at your marginal rate, which becomes increasingly costly as income grows.
2. What Is a Limited Company?
A limited company is a separate legal entity from you as an individual. When you set one up, you incorporate it at Companies House, appoint yourself as a director (and usually a shareholder), and your business operates in the company's name rather than your own.
This separation matters for two key reasons. First, your personal liability is limited to what you've invested in the company — if the business fails, your personal assets are generally protected. Second, the tax treatment is fundamentally different, and for many people, more efficient.
The company pays Corporation Tax on its profits. You as director can pay yourself a combination of salary and dividends, which is typically more tax-efficient than taking all income as employment earnings. The company can also retain profits, giving you flexibility over when and how you extract money.
The trade-off is additional administration. Limited companies must file annual accounts with Companies House, submit a Corporation Tax return to HMRC, maintain a payroll, and keep statutory records including minutes of decisions and a register of shareholders. There are also Companies House filing fees and — for most people — a greater need for professional accountancy support.
3. Tax and Take-Home Pay — The Key Differences
This is where the numbers start to matter. The tax picture looks quite different depending on which structure you choose.
As a sole trader
Your profits are taxed as personal income. For 2025/26, in England, Wales, and Northern Ireland:
The first £12,570 is covered by your Personal Allowance and is tax-free
Profits between £12,570 and £50,270 are taxed at 20% (basic rate)
Profits between £50,270 and £125,140 are taxed at 40% (higher rate)
Profits above £125,140 are taxed at 45% (additional rate)
Note: if your income exceeds £100,000, your Personal Allowance is gradually reduced — disappearing entirely at £125,140. Scottish taxpayers pay different income tax rates.
On top of Income Tax, sole traders pay Class 4 National Insurance contributions: 6% on profits between £12,570 and £50,270, and 2% on profits above that. Class 2 NICs were effectively abolished from April 2024 — if your profits exceed the Small Profits Threshold (£6,845 for 2025/26), a National Insurance credit is automatically applied, counting towards your State Pension with nothing to pay. If profits fall below this threshold, you can make voluntary Class 2 contributions of £3.50 per week to protect your State Pension record.
As a limited company director
The company pays Corporation Tax on its profits:
19% small profits rate on profits up to £50,000
25% main rate on profits above £250,000
Marginal relief applies on profits between £50,000 and £250,000
You then pay yourself through a combination of salary and dividends.
Salary: The optimal director salary for 2025/26 depends on your circumstances — specifically whether your company can claim the Employment Allowance. From April 2025, employer National Insurance is charged at 15% on any salary above £5,000 (the new Secondary Threshold, reduced from £9,100). This changes the calculation significantly compared to previous years.
For most sole directors of small limited companies who cannot claim the Employment Allowance, the most common approaches are:
£6,500 per year (the Lower Earnings Limit) — no employer NI, no income tax, no employee NI, and the year counts towards your State Pension
£12,570 per year (the Personal Allowance) — no income tax, no employee NI, but the company pays employer NI at 15% on the £7,570 above the £5,000 threshold (approximately £1,136). The Corporation Tax saving on the higher salary typically outweighs this cost, making £12,570 the most tax-efficient option for many
If your company has at least one other employee paid above the Secondary Threshold, it may be eligible for the Employment Allowance (£10,500 for 2025/26), which offsets employer NI costs and makes £12,570 the clear optimum.
The right salary level genuinely depends on your individual position, and we calculate the correct figure for every client.
Dividends: These are paid from post-Corporation Tax profits and taxed at lower rates than employment income:
The first £500 is covered by the Dividend Allowance (tax-free)
Dividends within the basic rate band are taxed at 8.75%
Dividends in the higher rate band are taxed at 33.75%
Dividends in the additional rate band are taxed at 39.35%
Dividends are not subject to National Insurance, which is one of the key reasons the salary-plus-dividends approach is so tax-efficient.
4. Admin, Costs, and Responsibilities
One of the most honest conversations we have with clients is about what a limited company actually involves in practice. The tax efficiency is real, but so is the administration.
As a sole trader, your obligations are relatively straightforward:
Keep records of all income and expenses
File one Self Assessment tax return per year
Pay any tax owed by 31 January
Register for VAT if your turnover exceeds £90,000
As a limited company director, your obligations are more extensive:
Incorporate the company at Companies House (one-off, around £50)
File annual accounts with Companies House (usually within 9 months of your accounting year end)
Submit a Corporation Tax return to HMRC
Run a PAYE payroll for your director's salary
Complete a personal Self Assessment tax return (because you're drawing income as an individual)
Maintain statutory records — minutes, shareholder register, and so on
File a Confirmation Statement at Companies House each year (currently £34)
The accountancy costs for a limited company are also higher than for a sole trader. At Barnett & Co, our fixed-fee packages cover all of the above, so you'll know exactly what you're paying from month one — no surprise invoices.
5. IR35 and Limited Companies
If you're considering a limited company because you work through contracts with clients — particularly in IT, engineering, finance, or professional services — you need to understand IR35 before you proceed.
IR35 is HMRC's off-payroll working legislation, designed to identify contractors who are in practice working like employees but using a limited company structure to reduce their tax liability. If a contract is determined to be inside IR35, the tax advantages of the limited company largely disappear — you'll be taxed as an employee on that income.
Whether a contract falls inside or outside IR35 depends on the real-world working arrangements, not just what the contract says. The key tests are:
Substitution: can you send a substitute to do the work instead of you?
Control: does the client control how and when you work, or just what you deliver?
Mutuality of obligation: is the client obliged to offer you work, and are you obliged to accept it?
Since April 2021, medium and large private sector clients are responsible for making the IR35 determination for their contractors. Small clients — those meeting two of the three criteria of fewer than 50 employees, turnover under £10.2 million, or a balance sheet under £5.1 million — leave the determination to the contractor.
If IR35 is relevant to your situation, getting a proper contract review and independent status assessment is essential. An incorrect determination in either direction can result in significant tax bills, interest, and penalties going back years.
6. Which Structure Suits Which Type of Person?
There's no single right answer, but there are some clear patterns we see in practice.
A sole trader structure tends to suit you if:
You're just starting out and want to keep things simple
Your annual profit is likely to be below £25,000 to £30,000
You work with multiple clients on short, varied engagements
You want minimal paperwork and administrative overhead
You're testing a business idea before committing to a more formal structure
A limited company tends to suit you if:
Your annual profit consistently exceeds £35,000 to £40,000
You work on longer contracts, often with a single client at a time
You want to retain profits in the business and control when you extract them
You want the protection of limited liability
You're building a business with employees, assets, or long-term growth in mind
A word on appearances: some clients mention that having a limited company looks more professional to clients. In some sectors this is genuinely true — certain clients, particularly in the public sector and larger corporates, prefer to contract with limited companies. But don't let this be the primary driver of the decision. The structure should suit your financial position first.
7. Can You Switch Later?
Yes — and many people do. It's common to start as a sole trader and incorporate once income grows to a level where the tax savings make a limited company worthwhile. Incorporation is a relatively straightforward process: you register the company at Companies House, transfer your business activities across, and notify HMRC of the change.
The reverse is also possible but less common. Closing a limited company and returning to sole trader status involves a formal process — either striking off the company (if it has no outstanding liabilities) or going through a Members' Voluntary Liquidation to extract retained profits in a tax-efficient way.
The important thing is not to assume the structure you start with is permanent. As your income changes, your personal circumstances evolve, or the nature of your work shifts, it makes sense to revisit the question periodically. At Barnett & Co, we review the optimal structure for clients as part of our annual accountancy work — not just when they first come to us.
8. Frequently Asked Questions
Can I be both a sole trader and a director of a limited company?
Yes. There's no rule against running a sole trader business and a limited company simultaneously. Some people operate a limited company for their main contracting work while keeping sole trader status for a secondary income stream. However, both must be reported separately to HMRC, and the combined income picture can become complex — professional advice is recommended.
Do I need an accountant if I'm a sole trader?
You're not legally required to use an accountant as a sole trader, but many people find the cost pays for itself in tax savings and avoided mistakes. Understanding what you can and can't claim, how to handle VAT, and how to plan your payments on account is where professional advice earns its keep.
How long does it take to set up a limited company?
Incorporation at Companies House can be completed online in as little as 24 hours, often faster. Setting up a business bank account typically takes longer — between one and four weeks depending on the bank. At Barnett & Co, we offer company formation as part of our new client onboarding, so the whole process is handled for you.
What is the VAT threshold and does it apply to both structures?
Yes — the VAT registration threshold (currently £90,000 in a rolling 12-month period) applies to both sole traders and limited companies. Once your taxable turnover exceeds this figure, you must register for VAT regardless of your business structure. You can also register voluntarily below the threshold, which may be beneficial if your clients are themselves VAT-registered.
What happens to my sole trader business if I incorporate?
When you incorporate, your business activities transfer to the new limited company. Existing contracts should ideally be transferred to the company, your clients should be informed, and any business assets may need to be sold or transferred. Your sole trader registration with HMRC will need to be wound up, and you'll need to file a final Self Assessment return covering your sole trader period.
How do I know which structure is right for me?
The best way is to model the numbers for your specific situation — income level, how you plan to extract money, your other income sources, pension contributions, and personal circumstances all play a role. We offer a free initial consultation at Barnett & Co where we work through this with you and give a clear recommendation. There's no obligation, and even if the answer is "stay as you are for now," you'll leave knowing exactly why.
Ready to make the right choice for your business?
Talk to Barnett & Co — a fixed-fee accountancy firm based in Crewe, working with sole traders, contractors, and limited companies across Cheshire and the entire UK.
📧 info@barnettandco.uk 📞 01270 861677 🌐 barnettandco.uk
This article is for general information only and does not constitute professional tax or financial advice. Tax rates, thresholds, and rules can change — the figures above relate to the 2025/26 tax year for England, Wales, and Northern Ireland. Scottish taxpayers are subject to different income tax rates. Please seek advice tailored to your own circumstances. Barnett & Co Accountants, Electra House, Electra Way, Crewe, Cheshire, CW1 6GL.
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