If you’re self-employed you can choose to operate either as a sole trader or a limited company.

Here, we explain the difference between them and how it will influence the tax you pay so that you can make the best decision for you. 

What’s the difference?

A sole trader: If you’re a sole trader, you run your own business as an individual and are self-employed. You can keep all your business’s profits after you’ve paid tax on them but you’re also personally responsible for any losses your business makes. 

A limited company: Is a type of business structure where the company has a legal identity of its own, separate from its owners (shareholders) and its managers (directors).

When do you need to set up as a sole trader?

If you’ve earned more than £1,000 from self-employment in the last tax year you’ll need to set up as a sole trader.

It can also be beneficial if you need to prove you’re self-employed, for example to claim tax-free childcare, and if you want to make voluntary Class 2 National Insurance payments to help you qualify for benefits. 

How do you become a sole trader?

To set up as a sole trader, you need to tell HMRC that you pay tax through Self Assessment. You’ll need to file a tax return every year

You’ll have to:

  • Keep business records and records of expenses
  • Send a self-assessment tax return every year
  • Pay income tax on your profits and Class 2 and Class 4 National Insurance
  • You must register for VAT if your annual turnover is more than £85,000

Those in the construction industry working as a contractor or subcontractor must register with HMRC for the Construction Industry Scheme.

How long does it take?

Setting up as a sole trader is relatively straightforward. All you need to do is contact HMRC and let them know you’re self-employed and will be paying tax as a sole trader.

Complete the HMRC registration form for self-assessment or online by post. 

Once this is activated and you’ve completed registration, HMRC will send you a 10-digit unique taxpayer reference and an activation code for your online account.

You can then complete your annual self-assessment tax returns using the online account. 

There’s no need to register with Companies House as a sole trader.

Key things to know

Tax dates

Here are the key dates you’ll need to remember when filing your self-assessment tax return

Action Deadline
Register yourself as a sole trader

5 October 22

Paper tax returns

Midnight on 31 October 22

Online tax returns

Midnight on 31 January 23

Pay the tax you owe

Midnight on 31 January 23

There’s usually a second payment deadline of 31 July if you make advance payments towards your bill (known as ‘payments on account’).

You’ll usually be required to pay a penalty if you’re late. 

Keep up to date financial records

You must keep records of your business income and expenses for your tax return if you’re self-employed as a sole trader. In addition, you’ll have to keep records of your personal income. 

You’ll also have to keep a record of expenses - you can deduct these costs to work out your taxable profit as long as they’re allowable expenses. 

Allowable expenses do not include money taken from your business to pay for private purchases.

They do include: 

  • office costs, for example stationery or phone bills.
  • travel costs, for example fuel, parking, train or bus fares.
  • clothing expenses, for example uniforms.
  • staff costs, for example salaries or subcontractor costs.
  • things you buy to sell on, for example stock or raw materials.
  • financial costs, for example insurance or bank charges.
  • costs of your business premises, for example heating, lighting, business rates.
  • advertising or marketing, for example website costs.
  • training courses related to your business, for example refresher courses.

Names matter

You can trade under your own name, or you can choose another name and it does not need to be registered.

You must include your name and business name on official paperwork such as invoices and letters.

Sole trader names must not:

  • include ‘limited’, ‘Ltd’, ‘limited liability partnership’, ‘LLP’, ‘public limited company’ or ‘plc’
  • be offensive
  • be the same as an existing trade mark
  • Cannot contain a ‘sensitive’ word or expression, or suggest a connection with government or local authorities, unless you get permission.

Should I set up a Limited Company?

As your profits grow, you could lower your tax bill by becoming a limited company.

This is because limited companies pay corporation tax on their profits which is currently at 19%,  rather than income tax which rate varies depending how much you earn, but could be as high as 45%.

Although setting up a limited company is more complicated and involves costs and paperwork, it could give you benefits such as limited liability and greater borrowing power. 

How long does it take?

There are a number of steps you’ll need to take to create your company, this includes finding a name, choosing a director and shareholders and preparing documents agreeing how you will run your company.

A step-by-step guide can be found on the Government website.

Once all these are in place you’ll have to register your business with Companies House. This can be completed within 24 hours if done online. 

Postal applications can take 8-10 days. 

How much does it cost?

It costs £12 to register your business online with Companies House. By post it can cost £40.

What’s right for you?

Choosing between a sole trader and a limited company is dependent on your personal circumstances as there are advantages and disadvantages to both. 

A sole trader is the easiest structure to set up and involves a limited amount of paperwork and obligations. However, you are taking on all the risks associated with the business and it’s less tax-efficient. 

A limited company is more complicated and involves more costs and paperwork. However it is more tax-efficient and is legally separate from shareholders and directors so you are not personally liable for any losses made in the business. 

Don’t rush the decision and speak to an accountant if you are unsure. 

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