When launching a new business or reassessing your current setup it’s important to choose the most appropriate legal structure. The two most common options in the UK are operating as a sole trader or forming a limited company. Each route has its own advantages and drawbacks, particularly in relation to tax, liability, and administration.
At Ascentis, we regularly help business owners weigh up these options to find the right fit for their circumstances.
What is a Sole Trader?
As a sole trader, you and the business are legally the same entity. It’s the simplest and most direct way to get a business up and running, which makes it a popular choice for freelancers, contractors, and small business owners.
Advantages of Being a Sole Trader:
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Low Setup and Admin:
Registering as a sole trader is quick and easy, with no need to go through Companies House. There are fewer ongoing obligations too, such as no requirement to file annual company accounts, making this a hassle-free structure for those starting small or operating on their own.
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Straightforward Tax Process:
Tax is calculated based on your annual business profits and submitted via a Self Assessment tax return. You’ll pay income tax and Class 2 and Class 4 National Insurance contributions. For many, the simplicity of this process is a major benefit.
Disadvantages of Being a Sole Trader:
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Unlimited Liability:
There’s no legal distinction between you and your business. That means if your business faces financial difficulties or legal claims, your personal assets (such as your savings or home) could be at risk.
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Fewer Tax Planning Opportunities:
While the tax process is simpler, sole traders don’t have access to the same tax planning strategies as limited companies. For example, you can’t pay yourself in dividends or take advantage of corporation tax rates, which could result in higher tax liabilities as your profits grow.
What is a Limited Company?
A limited company is a separate legal entity from its owner(s). You become a shareholder and director of the business, with specific legal responsibilities but also some key protections.
Advantages of a Limited Company:
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Limited Liability Protection:
Your financial risk is limited to the value of your shares. This separation between personal and business finances offers a level of security many business owners find reassuring, especially if your work involves contractual risk or significant investment.
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Potential for Greater Tax Efficiency:
Limited companies pay Corporation Tax on profits, which is often lower than higher rates of income tax. Directors can pay themselves a modest salary (often below the personal allowance threshold) and take additional income as dividends, which are taxed at lower rates. This allows for more flexible tax planning and, in many cases, a more efficient take-home pay structure.
Disadvantages of a Limited Company:
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More Administration and Compliance:
Running a limited company comes with stricter obligations. You’ll need to file annual accounts, maintain statutory records, submit confirmation statements, and comply with Companies House and HMRC requirements. Many business owners choose to appoint an accountant to help manage these obligations.
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Complexity Around Tax and Withdrawals:
Although limited companies can offer tax advantages, they also introduce more complexity. Drawing money from the business—whether through salary, dividends, or director’s loans—needs to be planned and documented correctly. You may also need to set up and run a PAYE payroll scheme.
So, Which Structure is Right for You?
There’s no one-size-fits-all answer. If you’re just starting out and want to keep things simple, becoming a sole trader may be ideal. But if you’re earning more, taking on risk, or looking to scale, a limited company could offer more flexibility and tax efficiency.
At Ascentis, we help entrepreneurs and business owners understand the financial and tax implications of each option based on their goals.
If you need help with this, or with other advice, then please get in touch with our accounting team.