Sole Trader vs. Limited Company: Choosing the Right Setup
Feeling uncertain about your business setup? In today’s episode, we’re tackling one of the biggest decisions for freelancers in the UK—should you be a sole trader or set up a limited company?
I’m joined by Janet Knapton, a Chartered Accountant and expert in helping freelancers make smart, tax-efficient decisions. Janet breaks down the pros and cons of both structures, helping you decide which one is right for you and your business.
You’ll get clear, simple, and actionable steps to make this crucial decision, and tips on staying tax-efficient while focusing on what matters most: growing your business.
You can listen (24 min) and subscribe here:
Now available on: Apple Podcasts | Spotify | Podlink
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Here are some key takeaways from the discussion:
LEGAL DISTINCTION
As a sole trader, you are your business. You keep all the profits, but you’re also responsible for any debts. There’s no separation between your personal finances and your business, which can get messy if something goes wrong.
On the other hand, a limited company is like giving your business its own identity. It’s a separate legal entity, which means your personal assets—like your home or savings—are protected if the business runs into trouble. It’s not just about protection, though; a limited company can also bring extra credibility, especially when working with bigger clients.
"A sole trader is personally liable for all the debts of the business, whereas with a limited company, the debts and legal issues are limited to how much the person has invested in the business."
2. TAX TALK
Here’s where it gets interesting. As a sole trader, you pay tax on everything you earn, and once you cross £50,270, you’re into the 40% higher tax bracket. Ouch.
With a limited company, you have more control. You can pay yourself a small salary (around £12,570 to use your tax-free personal allowance) and then take the rest as dividends. Dividends are taxed at a lower rate than income, so you keep more of your hard-earned cash. Essentially, you’re splitting how you pay yourself to make it as tax-efficient as possible.
"You can pay yourself in a mixture of a salary and a dividend, which really enables you to ensure that you're paying tax in the most efficient way possible."
3. VAT THRESHOLD
If your business earns £90,000 or more in a 12-month period, you’ll need to register for VAT. It’s not as scary as it sounds, but it does mean more paperwork—and possibly a higher price tag for your clients.
The key is to track your income carefully. It’s all about being proactive. If you’re approaching the VAT threshold, register before you’re required to—otherwise, you could end up footing the VAT bill yourself for past invoices.
"If you’ve already invoiced clients and you didn’t register for VAT in time, you’ll have to pay it out of your own pocket."
4. bUSINESS BANK ACCOUNTS
You can run your freelance business through a personal bank account as a sole trader, but it’s far from ideal. Mixing personal and business finances is a recipe for confusion.
A business bank account not only makes bookkeeping easier, but it also helps with tax time. These days, you’ve got loads of options—like Tide, Starling, or Revolut—that are flexible, affordable, and simple to set up. For limited companies, having a business account is non-negotiable.
"There are lots of good options these days like Tide, Starling, and Revolut, which make it simple and affordable to open a business account."
5. DO THE MATHS
If you’re earning close to £50,000, it might be time to think about making the switch to a limited company. Why? Because at this point, the tax savings can be significant.
Here’s a rough idea: As a sole trader, everything you earn above £50,270 gets taxed at 40%. With a limited company, you’d pay corporation tax on your profits (25%), but by splitting your income between salary and dividends, you’d likely end up keeping more of your earnings.
6. ALL ABOUT DIVIDENDS
Dividends are how you pay yourself from the company’s profits (after corporation tax). They’re not subject to national insurance contributions, and the tax rates are lower than income tax.
For example, the first £1,000 of dividends is tax-free. After that, dividends are taxed at 8.75% for basic-rate taxpayers, compared to 20% or more for regular income. It’s a game-changer for freelancers who want to maximise their income.
"Dividends are taxed at a lower rate than income and aren’t subject to national insurance contributions, making them a tax-efficient way to pay yourself."
7. FINAL THOUGHTS
There’s no one-size-fits-all answer, but here’s the bottom line: If your business is growing, you’re earning £50,000 or more, or you want added credibility and protection, it’s probably time to go limited.
That said, the jump to a limited company comes with extra admin and costs (hello, accountants and statutory reports). But if you do the maths, you might find the savings and peace of mind are well worth it.
Still unsure? Speak to an accountant or financial advisor—they’ll help you figure out what’s best for you and your business.
"It gives you peace of mind knowing that everything is running smoothly, your taxes are set aside, and you’re not paying unnecessary tax."
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