What’s the Difference Between Sole Trader and Limited Company?

If you are starting a new business in the UK, it means you need to choose a company structure that is easy to manage and supports your growth ambitions. Your first major hurdle can be choosing between a sole trader or limited company. Before selecting a trading structure, you need to understand the difference between sole trader and limited company.

So, to make it easy for you to decide between these two options, we explore the difference between a sole trader and a limited company in the UK. This blog explains limited company vs sole trader advantages and disadvantages, legal requirements, tax implications, and more.

What is the Difference Between Limited Company and Sole Trader?

A sole trader is a business owner who operates their own business by themselves. This means they have full control over their business. However, they also face unlimited personal liability for debts.

On the other hand, a limited company is a separate legal entity that owns its assets and finances. This protects the owner with limited liability.

To quickly learn the difference between sole trader and limited company, look at the following table:

Disclaimer: The information in the table is for general guidance only, and it does not constitute tax or financial advice.

Understanding the Main Difference Between Sole Trader and Limited Company?

The main difference between a limited company vs sole trader is legal structure. This means how UK law views the relationship between you and your business.

Being a sole trader means you and your business are legally identical. You own all profits directly. However, you are personally responsible if you face debts.

In contrast, a limited company is a separate legal person from its owner. The company owns its own money and carries its own debts, creating a financial shield to protect personal assets.

For instance, if a limited company goes bankrupt, the company closes, but your personal bank account and house are safe. Nonetheless, if a sole trader goes bankrupt, your personal assets can be taken to pay the debts.

What Are the Advantages of Sole Trader vs Limited Company?

To better understand the difference between sole trader and limited company, you should know the sole trader vs limited company pros and cons. Some of the pros and cons of limited company vs sole trader are:

Advantages of Being a Sole Trader

Being a sole trader is easier than being a limited company because:

• It is simple to set up as a sole trader.
• There are fewer administrative requirements.
• You can directly control the business.
• There is relatively simple accounting and tax reporting.
• You can keep the business profits after tax.
• You can change to a limited company if the circumstances change.

Disadvantages of Being a Sole Trader

Although it is easier to be a sole trader, there are some cons, including:

• Sole traders are personally responsible for the debts if the business fails.
• A sole trader business succession can be less straightforward because the sole trader does not own shares in a separate legal entity. Instead, the business goodwill, assets, and other relevant interests may need to be transferred or sold.

Now let’s discuss the second part of the difference between sole trader and limited company:

Advantages of Being a Limited Company

Being a limited company has many advantages, such as:

• A shareholder’s personal liability is limited. This means that if the company goes bankrupt, you do not lose your personal belongings. Hence, personal assets are protected from business debts.
• Your limited company needs to pay Corporation Tax on profits. Depending on the circumstances, incorporation can sometimes offer tax-planning opportunities, but dividends and other withdrawals may create additional personal tax liabilities.
• Company owners can take a mix of a small salary and dividend payments to lower their overall tax bill.
• A limited company can make it easier to divide ownership and get investors. It may also provide a more formal structure when seeking finance, although lenders may still assess the business and request personal guarantees.

Disadvantages of Being a Limited Company

Although being a limited company offers several benefits, there are some disadvantages, such as:

• There is more paperwork. You must file annual accounts and confirmation statements with Companies House.
• Setting up a limited company can cost more, and accountants may charge more to manage company tax returns and other formal reports.
• Because your company’s financial records, registered office address, and director’s details may be available on a public register, there may be less privacy.

Should I Be a Sole Trader or Limited Company?

Now that you understand the difference between sole trader and limited company, let’s discuss which business structure can be the best option for you.

So, if you are wondering which business structure is the best for you, the answer is that neither structure is universally better. If you are launching a small business and want a straightforward structure, becoming a sole trader may be appropriate.

However, if you want a separate legal entity, plan to have shareholders, or intend to retain profits within the business, you should choose a limited company.

How Do I Become a LTD Company?

In the UK, to set up a private limited company, you need to:

• Choose a unique business name
• Then you need to decide whether your company will be limited by shares or guarantee.
• Appoint at least one director and also decide who the shareholders are.
• Identify the company’s PSCs.
• Get a UK registered office address
• Complete mandatory identity verification.
• Prepare the required company documents
• Register the company with Companies House online through GOV.UK.
• Register for Corporation Tax and other taxes where applicable.

When Should I Change From Sole Trader to Limited Company?

Once you know the main difference between sole trader and limited company, you can decide when to change from sole trading to limited company.

Generally, you may consider switching from a sole trader to a limited company when your annual profits regularly exceed £30,000 to £50,000, although it’s not a universal profit threshold. At this financial threshold, the potential tax or other benefits of incorporation outweigh the additional accounting and administrative costs.

How to Go From Sole Trader to Limited Company?

To move from being a sole trader to a limited company, you need to:

• Set up and register the new company with Companies House
• Tell HMRC that you have stopped trading as a sole trader
• Register the company for Corporation Tax when required.
• Open a separate business bank account, and transfer any relevant business assets, contracts and other interests to the company where appropriate.
• Submit your final Self Assessment tax return as a sole trader.

Final Thoughts on Difference Between Sole Trader and Limited Company

In conclusion, one of the key differences between a sole trader and a limited company is the legal status. As a sole trader, you run a business personally. On the other hand, a limited company is a separate legal entity from its owners. Legal status can affect liability, taxation, administration, record-keeping and how profits are taken from the business.

So, when you are selecting a structure, you should consider the tax implications, costs, administrative requirements and legal responsibilities. Do not rely solely on headline tax rates.

If you need an accountant to manage your accounts, taxes, and identify potential risks and liability considerations, we are here to help. At MicroEntityAccounts, we have the best accountants who can manage your financial records and tax matters effortlessly while ensuring compliance with HMRC. Get a quote today!