Sole Trader Vs Limited Company for New Freelancers

It's nine years this year since I made the switch from sole trader (Lisa Slater Copywriting) to limited company (Make Your Copy Count Ltd).

I'd been freelancing for three years, but I wanted my business to be more than "just" me. I wanted to be a "proper" business.

These days, I'm more than happy being just me, and I realise that a one-person business is still a proper business. But back then, I'd let myself get caught up with whatever people's idea of success looked like.

That wasn't my only reason for making the switch, but it was one of them. And the reason I'm mentioning it is that I want you to know that how you choose to operate when you start out doesn't have to be the way you operate forever. You can switch between sole trader and limited company or vice versa.

So now that's cleared up, here's a quick overview of the key differences.

A sole trader is a single individual who runs their own business and works for themselves. That means they make all the decisions, have all the liability, cover all the costs and keep any profits. Being a sole trader doesn’t necessarily mean there is only one person in the business – a sole trader can hire employees.

A limited company can be formed by one or more people who will be the named directors. The company is its own legal entity, and the business finances and assets are separate from personal finances and assets. Limited companies are registered at Companies House.

If you are starting a business with someone else, you may want to enter into a partnership or Limited Liability Partnership (LLP). I won’t be covering partnerships and LLPs here, but you can check out the government website to find out how it works.

Registration & set up

Registering as a self-employed sole trader

To start trading as a sole trader, you simply need to register as self-employed with HMRC.

You do not have to do this immediately, but you must register if you have earned more than £1,000 in the previous tax year. You must register before 5th October in the business’s second tax year, or you could face a fine.

Once registered, you must complete a self-assessment tax return after every tax year. The UK tax year runs from 6th April to 5th April.

You can register here.

Setting up a limited company

Forming a limited company is not difficult, but it involves slightly more administrative work and a very small cost (currently £50).

You need to register the company with Companies House. This is quite straightforward, and you can do it yourself. Alternatively, numerous third-party companies or accountants will help you do it for a small admin fee.

You will need to choose a business name, name the directors, and allocate shares. You will also need a registered address. If you don’t have an office address, you can use your home address. Alternatively, you can pay to use a registered address service.

Once your company is registered, you will receive a certificate of incorporation showing your unique company number and the date of incorporation.

You can register a limited company here.

Company names and trading names

You do not need a company name to start trading as a freelancer – you can trade under your own name for as long as you want.

As a sole trader, you can use your name as the company name, but you can also use a trading name if you want to.

You do not need to register your trading name, but your trading name is not protected. If somebody else decides to register a limited company using that name, they may do so.

If you are trading as a sole trader, you cannot use the words’ Ltd’ or ‘limited’ in your trading name. Your name must not be offensive, and there are some words you must avoid or get permission to use – for example, words that suggest a connection with government or local authorities.

Official documents, invoices and contracts must include your name. You can then add 'trading as' or 't/a' followed by your trading name – for example, John Smith t/a ABC Freelancers.

When choosing your company name, check Companies House to ensure your name isn’t too similar to another company in the same industry. If you use a name or logo that’s already in use or a registered trademark, the owner could take legal action against you.

If you are registering as a limited company, you register your business under your chosen name and can choose either Ltd or Limited to go at the end.

When you send official documents or letters, you should include your full company name – for example, ABC Freelancers Ltd. You do not have to include your name.

If you register as a limited company, no other business can register with the same name. However, they could register a similar company name. For example, there could be ABC Freelancers Ltd and ABC Freelancer Group Ltd and even ABC Yorkshire Freelancers Ltd.

Privacy

As a sole trader, you have more privacy than a limited company. When you register a company with Companies House, your name and registered address are available for anyone to view on the Companies House website.

You must also file your accounts with Companies House, and certain financial details are available for anybody to access if they so wish.

As a sole trader, you do not have to share your registration details or disclose financial information to the public. However, you will still have to include an address on any invoices and official documents.

Liability (and credibility)

One of the main advantages of registering as a limited company is that your business becomes a separate entity, meaning you are not liable for company debt or legal action against the business.

As a sole trader, you are personally liable if your business gets into debt or you are sued.

This means you may be forced to sell personal assets, such as your home, to pay off debts. If things go horribly wrong, you could end up having to file for bankruptcy.

As a limited company, your business is not linked to your personal accounts. If you get into debt, your company is liable. If you cannot pay, you may have to wind down your company, but your personal savings and assets are usually protected (unless you have been involved in fraudulent activities).

Some businesses are more at risk than others. For example, a copywriter working from home on a laptop will have less financial risk than a builder who will have to pay for vehicles, equipment and materials. A copywriter is also less likely to get sued. Poor copy will cause minimal cost or damage to a company, whereas a badly built property could put lives at risk.

Regardless of whether you go down the sole trader route or register as a limited company, you should ensure that you have adequate insurance. Most freelancers get professional indemnity insurance as a minimum.

Registering as a limited company can help with credibility.

Details about your company and finances are available on Companies House, and this transparency can make companies feel more at ease when doing business with you.

Some organisations won’t offer contracts to sole traders because of the liability risk. Some banks and lenders are also wary of lending to sole traders, so securing business loans or investments can be more difficult.

Accounting

Some of the main differences between sole traders and limited companies come down to accounting - the way you pay yourself, the way you pay tax, and the information you need to send to HMRC.

Paying yourself and paying tax

As a sole trader, you can pay yourself as and when you need to from the business. You must keep accurate records of business income and expenditure to complete your annual self-assessment. You will then pay income tax on your profits.

In the simplest terms, you record everything you have earned, deduct all your business expenses, and then pay tax and national insurance (NI) on whatever is left over (above the annual personal allowance).

As a limited company, you can still take money from your business, but you report it slightly differently. Many directors take a combination of salary and dividends.

You pay income tax and NI on your salary (just as you would if you were a sole trader). You also pay income tax on dividends, but the rate is much lower, you don't pay NI on them, and you get a very small tax-free allowance.

However, you can only take dividends if you are in profit.

In addition to personal tax, Limited Companies must pay Corporation Tax on all profits. Your salary is deducted from your profit, so is not subject to Corporation Tax. Dividends are included in your profit, so you will pay Corporation Tax on them (as well as personal income tax).

If you need to borrow money from your business, it is also possible to do this in the form of a Director's Loan. You must record all transactions to track what you have taken from your business and what you have borrowed.

Rates of corporation tax, dividend tax, and income tax go up and down, so how you pay yourself may need to change. That’s why it pays to have a good accountant, and I highly recommend getting one. An accountant can help you determine whether tax savings can be made by forming a limited company

Annual accounts

As a sole trader, you must submit a self-assessment to HMRC each tax year. This is relatively simple if you have accurate records of your income and expenditure. You let HMRC know how much your business has been paid and how much you have spent. They will then calculate how much tax you need to pay. If you don't feel confident filling in a self-assessment, you can pay someone to help you with this.

As a limited company, you still have to file a self-assessment for your personal income (salary, dividends, and any other income). But you must also file company tax returns with HMRC and Companies House each year. You will be fined if you do not submit the required information by the set deadlines.

It’s a good idea to get an accountant to take care of filing your returns on your behalf.

Bank accounts

You’re not legally required to set up a business bank account, but it makes managing your finances much easier and can help you build a credit history for your business.

You may also get additional features with a business account that aren’t available with a personal account.

It’s also worth noting that some banks specify in their terms and conditions that you cannot use your personal account for business transactions, so you might have to open a separate account.

As a limited company, your business is a separate legal entity, and the money belongs to the company, so it must be kept separately. There are plenty of business bank accounts to choose from, but it's worth doing some research before committing, as fees can vary.

VAT registration

Regardless of whether you are a sole trader or a limited company, you must become VAT registered if you exceed the VAT taxable turnover. 

It is possible to register for VAT before you exceed the threshold, and many companies decide to become VAT registered even if they don’t have to. Sometimes this is to give the impression they are more profitable than they are, but usually, it is so they can reclaim VAT on business supplies.

If all your suppliers are VAT registered, it might make sense for you to become VAT registered too, so you can offset the VAT you pay. However, if all your clients are non-VAT registered, they won’t be able to offset the VAT, and the extra 20% you need to charge could impact sales.

An accountant can help you decide if this is the right route for your business.

Employing and paying staff

You can employ staff regardless of whether you are a sole trader or a limited company.

Whatever type of company you are, you must meet all the legal requirements regarding tax, NIC and pensions. You will have to set up a PAYE scheme to ensure that you meet these requirements – many companies outsource this to an accountant or bookkeeper.

Making the right choice

As I said at the start of this article, you can switch from sole trader to limited company and back again with relative ease (although it's not something you should be doing regularly).

The right choice for you will depend on several factors. What type of services you offer, how high your turnover is likely to be, the level of financial risk, what kind of clients you'll be working with and so on. If you are still not sure, then I highly recommend speaking to an accountant who will help you understand the pros and cons of each.

This article is only meant as a very basic overview and doesn't cover all the pros, cons and risks, so if in doubt, seek professional guidance.