Deciding how to structure your business is one of the first big decisions you’ll make when becoming self-employed. It pays to get it right from the start.
I’m not going to lie… it took me about eight months to get my head around this before I incorporated my first Limited Company, so my goal here is to shorten your learning curve.
Let’s look at the three main options:
- Sole Trader
- Limited Company
- Partnership (I’ll only briefly cover this).
You’ll learn the pros and cons of each, see some real-world numbers, and get to the bottom of which one might suit your situation.
Stick around for the decision tree at the end – it could save you a headache or two.
Option 1: Sole Trader
This is by far the simplest and most common way to start a business in the UK. As a Sole Trader, you and your business are legally the same entity, which means you’re personally responsible for any debts the business incurs.
How it works as a Sole Trader
- To set up, you’ll need a National Insurance number and you must register with HMRC for self-assessment if you earn more than £1,000 in a tax year (6 April – 5 April).
- You’ll file an annual tax return and pay income tax and National Insurance Contributions (NICs) on your profits.
Currently, these are the rates:
- Class 2 NICs: As of April, Class 2 is now voluntary rather than mandatory. If you earn less than £6,845, you can still pay Class 2 NICs at £3.50/week (2025/26). For those with profits between £6,845 and £12,570, you get NICs without having to pay the tax.
- Class 4 NICs: 6% on profits over £12,570, plus 2% on profits above £50,270.
Pros:
- Easy to set up: Register with HMRC in minutes — no Companies House faff required.
- Low costs: No incorporation fees, and accounting can be done cheaply with tools like QuickBooks (get 90% off with this QuickBooks link)
- Flexible: Great for side hustles or testing a business idea. You can always incorporate later.
Cons:
- Unlimited liability: If things go south, your personal assets (like your house) are at risk.
- Higher taxes as you earn more: Sole Traders pay income tax rates of 20%, 40%, or 45%, which can quickly feel steep.
- Perception: Larger clients might see you as less professional compared to a Limited Company.
Example tax breakdown for a Sole Trader
Let’s say you earn £60,000 in profits as a Sole Trader:
- Income Tax: 20% on £37,700 (£50,270 minus £12,570 tax-free allowance) + 40% on £9,730 (the amount above £50,270).
- NICs: Class 4 NICs: 6% on profits over £12,570, plus 2% on profits above £50,270.
You’ll pay roughly £14,000 in tax and NICs.
Option 2: Limited Company
A Limited Company is a separate legal entity, which means its finances are distinct from your personal finances. This isn’t just paperwork – it’s a mindset shift. You’re no longer you, the freelancer; you’re you, the Director of a Limited Company.
How a Limited Company structure works
- Register with Companies House (£12 online fee).
- File annual accounts with HMRC and Companies House.
- Pay Corporation Tax on profits (19% for profits under £50,000 in 2024/25).
- Pay yourself via a mix of salary and dividends for tax efficiency.
Pros:
- Tax efficiency: Beyond £50,000 in profits, a Limited Company can save you a significant amount in tax.
- Professional image: Larger clients often prefer working with Limited Companies.
- Limited liability: Your personal assets are protected if the business runs into trouble.
- Growth potential: Easier to raise funding and onboard shareholders.
Cons:
- More admin: Annual accounts, confirmation statements, and PAYE if you take a salary.
- Costs: Accountants typically charge upwards of £75+VAT/month – and more if you need full PAYE, VAT returns, and other services.
- Director responsibilities: Legal obligations to act in the company’s best interest and file accurate accounts.
Example tax breakdown for a Limited Company
Let’s say your Limited Company earns £60,000 in profits:
- Corporation Tax (19% on £60,000): £11,400.
- Salary: Take £12,570 tax-free split into 12 monthly payments.
- Dividends: Take the rest (£36,030 after Corporation Tax). Pay no tax on the first £1,000 (dividend allowance), then 8.75% on the rest.
You’d pay around £14,200 in tax – saving nearly £3,000 compared to the Sole Trader setup.
Remember, I’m not an actual accountant, I’m just showing you at a high level what the difference is. If you’re in the market for an accountant I give out my ‘power team’ list to my subscribers only, or you can easily search for someone near you through Unbiased.
Option 3: Partnership
A Partnership is where two or more people run a business together, sharing profits (and liabilities). It’s similar to a Sole Trader setup but with shared responsibilities.
Noteworthy: Partnerships can be tricky, especially if one partner wants out. I’m skipping the details here because they’re not right for most people. If you’re curious, check out this clear guide to Partnerships.
Key questions to ask yourself
1. How much will I earn?
If profits are under £50,000, a Sole Trader setup is likely simpler and cheaper.
Over £50,000? A Limited Company could save you tax.
2. How much risk is involved?
If there’s a chance of debts or legal issues, go Limited to protect your personal assets.
3. How important is professionalism?
A Limited Company often looks more credible to clients, especially for larger contracts.
4. Am I working alone or with others
Sole Trader is ideal for solo ventures. Partnerships require trust and shared liability.
Decision Tree
Step 1: Are you working alone?
- Yes: Go to Step 2.
- No: Consider a Partnership.
Step 2: Are your profits above £50,000 annually?
- Yes: A Limited Company might save you tax.
- No: Go to Step 3.
Step 3: Are you worried about personal liability?
- Yes: A Limited Company offers more protection.
- No: Sole Trader is simpler.
Conclusion
Choosing between Sole Trader and Limited Company is a balancing act of simplicity, liability, and tax efficiency. If you’re just starting out or earning under £50,000, a Sole Trader setup is quick and easy.
But if your profits are higher, or you want to limit your personal risk, a Limited Company may be the way to go.
Next steps:
- Register as a Sole Trader: HMRC.
- Set up a Limited Company: Companies House.
- Get professional advice: Find an accountant via Unbiased.
Still unsure? Drop your questions in the comments or book a free discovery call! For more info, contact Femme Finance today!
