The legal difference
A sole trader is a person trading in their own name (or under a trading name they've chosen). Legally, the person and the business are the same entity. If the business owes money, the sole trader owes that money personally — their house, their car, their personal bank account are all on the hook.
A limited company is a separate legal entity that you own (via shares) and probably also run (as a director). The company can owe money, sign contracts and be sued without your personal assets being at risk (provided you haven't given personal guarantees and haven't traded fraudulently).
This liability difference matters more than most people realise. If you do any work where mistakes could cost a client meaningful money — software development, construction, legal advice, design with IP implications — a limited company is worth setting up purely for the liability protection, regardless of the tax position.
Tax treatment side by side (2026/27)
Sole trader
- All profit treated as your personal income
- Personal allowance £12,570 tax-free
- Income Tax: 20% / 40% / 45% in the standard rest-of-UK bands
- Class 4 NI: 6% on profit £12,570 to £50,270, then 2% above
- Class 2 NI: abolished from April 2024 — flat weekly NI gone; NI credit for State Pension entitlement applies automatically if profits above £6,725
- Paid via annual Self Assessment, with payments on account each January and July if the tax bill exceeds £1,000
Limited company
- Company profit taxed at Corporation Tax: 19% on first £50,000, marginal relief band £50,000–£250,000 (effective 26.5%), 25% above £250,000
- You pay yourself a small director's salary — typically the £12,570 personal allowance — with zero Income Tax and minimal NI
- Remaining post-tax profit comes out as dividends
- £500 dividend allowance tax-free, then 8.75% (basic band), 33.75% (higher band), 39.35% (additional band)
- Two tax returns: company's CT600 (filed by your accountant) and your personal Self Assessment
Take-home comparison
The numbers below assume all profit is drawn out as personal income (no retained earnings), no pension contribution, no allowable expenses beyond the basics. Limited company column is gross of accountancy fees — deduct roughly £1,200-£1,500 a year for a like-for-like comparison.
| Annual profit | Sole trader net | Ltd company net | Ltd advantage |
|---|---|---|---|
| £20,000 | £17,470 | £17,200 | −£270 (sole trader wins) |
| £30,000 | £24,914 | £24,650 | −£264 (sole trader wins) |
| £40,000 | £31,514 | £31,700 | +£186 |
| £50,000 | £38,114 | £38,750 | +£636 |
| £60,000 | £44,094 | £45,500 | +£1,406 |
| £75,000 | £52,914 | £54,950 | +£2,036 |
| £100,000 | £68,114 | £72,500 | +£4,386 |
| £150,000 | £93,800 | £105,200 | +£11,400 |
After accounting fees, the switching point lands around £40,000-£45,000 of annual profit. Below that, sole trader is simpler and often cheaper. Above it, limited starts to clearly win.
Why limited company becomes more efficient at higher profits
Two structural reasons:
1. Dividends aren't subject to NI. The 6% Class 4 NI hit on sole-trader profit between £12,570 and £50,270 is real money — £2,262 a year at the upper threshold. Limited companies pay 19% Corporation Tax instead, and the 8.75% basic-rate dividend tax is much gentler than the 26% combined Income Tax + Class 4 NI hit a sole trader pays at the same income level.
2. Income smoothing. A sole trader pays full tax on all profit in the year it arises. A limited company can retain earnings (pay 19-25% Corporation Tax and stop there) and distribute dividends in later years when personal tax bands are more favourable — for example, a year when you've taken parental leave, gone part-time, or scaled the business down.
Things sole traders can't easily do
- Make big pension contributions through the business. A Ltd can pay up to £60,000 a year (the annual allowance) as employer pension contributions — these reduce Corporation Tax and don't count as your personal income. A sole trader has to use personal pension contributions, capped by their relevant earnings.
- Sell the business as shares. If you ever want to sell the business as a going concern, the Ltd company structure makes that a clean share transfer. Sole-trader "businesses" are typically sold as asset transfers with messier tax.
- Add co-owners cleanly. Want to bring in a business partner? Issue them shares. Sole trader to partnership requires unwinding the sole-trader structure first.
- Look "real" to bigger clients. Some enterprise procurement teams won't engage with sole traders at all.
Things sole traders can do that limited companies struggle with
- Take money out instantly. Sole trader profit is your money. Move £5,000 from business account to personal account whenever you want — it's just bookkeeping. Limited companies need dividend declarations (board minute required, even as sole director) or director's loans (with their own rules and tax consequences).
- Offset losses against other income. Sole trader losses in the first four years of trading can be carried back against PAYE income from previous jobs — a useful refund mechanism for people leaving employment to start a business. Limited losses can only be offset against company profits.
- Wind down without paperwork. Stop trading as a sole trader: file your final Self Assessment, that's it. Closing a Ltd company involves a strike-off process (DS01, 3 months of notice) or a Members' Voluntary Liquidation if retained cash is involved.
What it costs to run each
| Cost | Sole trader | Limited company |
|---|---|---|
| Setup | £0 (just register for Self Assessment) | £50 (Companies House) |
| Annual accountant | £250-£600 (optional) | £900-£1,800 (advisable) |
| Confirmation statement | — | £34/year |
| Business bank account | Personal account fine | Required, free options exist |
| Self Assessment | Required | Required (personal dividends + salary) |
| Corporation Tax return | — | Required (accountant does it) |
| Payroll for director | — | Free with most accountants |
| Approximate annual total | £0-£600 | £1,200-£2,000 |
The Ltd company's ~£1,500 net cost premium is the price of the tax efficiency and liability protection.
When to switch from sole trader to limited
Reasonable trigger points:
- Annual profit consistently above £40,000-£45,000
- You're taking on contracts where personal liability is a real risk
- You want to make substantial pension contributions through the business
- You want to retain earnings for a future investment, sabbatical, or business expansion
- You're approaching the VAT threshold (£90,000) and want a cleaner structure
- You're tendering for clients (often enterprise or public sector) who require a Ltd company
How to switch (high level)
- Form the Ltd company at gov.uk/set-up-limited-company. £50, takes 24 hours online
- Open a business bank account — free options at Tide, Starling, Revolut, plus traditional banks
- Register the Ltd for Corporation Tax within 3 months of starting to trade
- Set up PAYE for your director's salary (your accountant can do this)
- Transfer business assets from sole trader to Ltd at market value (usually a nominal amount for equipment, software)
- Notify clients of the new Ltd company name on invoices going forward
- Continue Self Assessment for the sole-trader period of the tax year alongside the Ltd structure for the post-switch period — year one is messy, year two is clean
- De-register from Self Assessment as a sole trader once all sole-trader income has been declared (usually a year after switching)
For the specific switching maths in your situation — particularly around timing the switch relative to the tax year — a one-hour consultation with a contractor accountant pays for itself.
In short
Sole trader is the right answer for most people starting out: lower cost, lower complexity, full tax efficiency for moderate profits. Limited company becomes the right answer once profits cross ~£40,000-£45,000 a year and you're confident the higher-profit pattern is sustainable. The switching cost (formation + first-year accounting overhead) is real but recoverable within one or two years at higher profit levels.
For the specific operational steps once you've decided, see how to set up a limited company and should I start a limited company? for the decision-framework view.