When establishing a new business in the UK most people consider setting up as a sole trader or forming a private limited company. Factors such as tax, accounting and administration as well as matters that affect you and your family such as the protection of your home and your savings in the event of business failure must all be considered. In this guide the main points of both options are outlined in plain English and a worked example using current tax rates (2026 / 2027) shows where the differences really are and where they are smaller than people tend to assume.
The two main options in plain English
A sole trader is someone who is running their own business but is treated as if they were that business, therefore any profits made would be classed as income and any debts as debts of that person. A limited company is treated as a separate legal person from its owners/directors. This means a company can own things, enter into contracts and even incur debt, all in its own name. Any individuals involved in a limited company are its shareholders (the owners of the company) and its directors (the people who run the company). Often in small companies these will be the same person. A limited company is registered at Companies House.
GOV.UK says most businesses set up as one of these types and can change to the other at a later date. It also says that moving from sole trader to limited company is usually easier than going the other way.
What a sole trader is: set-up, tax and liability
Setting up as a sole trader is the quickest way to start a business. You can start to trade immediately under your own name or using a business name. You will need to register for Self Assessment with HMRC once you earn more than £1,000 from self-employment in a tax year. You then have until 5 October following the end of the tax year in which you started trading to notify HMRC. You will then complete a Self Assessment tax return each year and pay Income Tax and Class 4 National Insurance on your trading profits.
For a sole trader, profit equals total income minus allowable business expenses. For the 2026 to 2027 tax year you will get the standard £12,570 Personal Allowance and pay Income Tax at the 20% rate up to the £50,270 amount and then at the higher 40% rate above that. Class 4 National Insurance is charged at 6% on profits between £12,570 and £50,270 and then at 2% above that amount. Class 2 contributions are no longer due if the total profit from trade for the year is £7,105 or more but are assumed to be paid to protect your National Insurance record.
The catch is liability. A sole trader has unlimited liability, which means you are personally responsible for every debt the business runs up. If a supplier is unpaid or a customer wins a claim against you, your personal assets are in the firing line. Insurance can cover some of that risk, but it cannot cover an ordinary trading loss.
What a limited company is: directors, shareholders and Companies House
A private limited company is formed by registering it with Companies House. The online registration fee is currently £100, the company is usually registered within 24 hours, and you will normally be set up for Corporation Tax at the same time. Before you register, each director now needs to verify their identity and will receive a Companies House personal code. You also need a registered office address, at least one director, at least one shareholder, and a set of articles of association setting out how the company is run (most small companies use the standard model articles).
After incorporation the company has certain obligations. A company must hold certain records. It must also prepare and file annual accounts and a Company Tax Return and pay Corporation Tax. In addition, a confirmation statement must be sent to Companies House at least annually and this must contain up to date information about the company. The work can be undertaken by accountants but the obligations remain legally with the directors of the company, and missing a deadline brings automatic penalties.
Limited liability: what it protects and what it does not
The main advantage of limited liability is that the shareholders are only liable for the debts of the company up to the amount of their investment. If the company fails owing money, the owners’ homes and savings will generally not be pursued by the creditors of the company for any amounts outstanding.
The protection of ‘limited liability’ has boundaries, however, and these are often overestimated by new founders. For example, when dealing with banks and landlords of property used by a small company, it is common practice to require the directors of the company to sign a personal guarantee in respect of a particular debt. Further, a director who continues to trade a company when they know it is unable to pay its debts may incur personal liability and may risk disqualification as a director for serious breaches of their duties. The director’s loan account will also record any monies withdrawn from the company not by way of salary or properly declared dividend, which may need to be repaid to the company on its demise. Limited liability is strong protection against normal business risk, but not against everything.
Tax compared: income tax and NI vs corporation tax and dividends
Corporation Tax is paid by a company on its profits. This is set at a rate of 19% where profits are £50,000 or less and 25% where they are above £250,000, with marginal relief applied in between. Most owner-directors extract cash from the company as a modest salary paid through payroll plus dividends, which are paid from taxed profits and then further taxed on the recipient as part of their income. For 2026/2027, each individual has a £500 dividend allowance, after which dividends are taxed at a 10.75% rate in the basic rate band, at 35.75% in the higher rate band and at 39.35% in the additional rate band.
A company also has to pay employer National Insurance of 15% on salaries above £5,000 per year. Where the only employee is a single director, this contribution cannot be offset with the Employment Allowance though, and is another reason to be wary of the old ‘rule of thumb’ of a limited company always saving tax once profits exceed a certain amount. The rule has to be checked against current rates rather than taken on trust.
Here’s a simplified worked example of how this works in practice for a business making £40,000 profit before paying its owner, in the 2026 to 2027 tax year. We have assumed the owner has no other income, lives outside Scotland and makes no pension contributions. We have also assumed that the owner of the business takes out every penny. In the case of a company the director takes a £12,570 salary and the remainder of the profit as dividends.
| £40,000 profit, 2026 to 2027 | Sole trader | Limited company |
|---|---|---|
| Employer National Insurance | None | £1,136 |
| Corporation Tax (19%) | None | £4,996 |
| Income Tax on profits or salary | £5,486 | £0 |
| Class 4 National Insurance | £1,646 | None |
| Dividend tax | None | £2,236 |
| Total tax and NI | £7,132 | £8,367 |
| Left in the owner’s pocket | £32,868 | £31,633 |
In these circumstances the sole trader keeps about £1,200 more than they would by trading through a company. Furthermore, the higher accountancy costs which would normally be incurred by a company trading structure are not taken into account. However, if the owner does not need to extract all of the profit from the business then the profit left in the company will be taxed at 19%, compared with a top combined rate of 26% for a sole trader trading in the basic rate band and 42% in the higher rate band, so a business building up cash for equipment, premises or a quiet year can come out ahead as a company. Also, pension contributions paid by the company, other household income and attempts to bring in other investors all have to be added into the sums. Therefore, the example above is intended to be used only as a starting point for discussion with an accountant.
Paperwork and admin each structure brings
Admin costs are worth weighing up before you choose. A sole trader will record income and expenditure throughout the year and complete a single Self Assessment form each year. A limited company, however, will require statutory accounts to be prepared in a set format plus a Company Tax Return, an annual confirmation statement, a payroll scheme if anyone is paid a salary (you are included in this), dividend paperwork and a personal tax return for each director who takes dividends above the allowances.
| Task | Sole trader | Limited company |
|---|---|---|
| Register | Self Assessment with HMRC | Companies House, then Corporation Tax and usually PAYE |
| Annual filings | Self Assessment return | Accounts, Company Tax Return, confirmation statement, directors’ personal returns |
| Public information | None required | Directors, registered office and accounts on the public register |
| Taking money out | Draw what you like; tax is on profit | Salary through payroll, dividends from available profit, or a recorded director’s loan |
| VAT | Register if taxable turnover passes £90,000 | Same threshold |
Dividends can have particular surprises in store for the unaware. Firstly, a dividend can only be paid out of a company’s available profits. Then there is the need for the directors to declare a dividend at a meeting (and minutes of that meeting must be kept) – even if there is only one director. And then there are the dividend vouchers which must be completed for each payment of dividend.
Credibility, contracts and getting paid
Some larger companies and public bodies want to work with limited companies. Part of this is perception and also risk management, such as understanding the employment status of contractors. A limited company also makes it easier to bring in co-owners or investors as the ownership is in shares which can be sold or transferred as required. However, there is no reason why a sole trader cannot be just as credible to most customers, and the public register of accounts allows anyone to view the filed accounts of a small company and see roughly how it is doing.
Credibility is often quietly generated by how you trade with clients. Clear terms and invoices sent on time, plus a good track record of delivering on your promises to clients, are more important to most small businesses than the word ‘Limited’ on a letterhead. Much of a business’s value is not captured on a balance sheet, whatever the business structure.
Switching from sole trader to limited company later
For many businesses, the first stage of life is as a sole trader – a simple, low-cost vehicle to test out ideas. When profits grow, and either risk or ambition begins to kick in, the businesses are transferred into a company structure. Registering a new company, transferring the trade across and telling HMRC that your self-employment has stopped is relatively straightforward. The point worth noting is that a company is a separate legal entity from its owners, so care is required in moving contracts, bank accounts, insurance policies and accounts with suppliers into its name, as well as getting customers to change their invoicing details.
There are other issues surrounding the transfer of equipment, stock and goodwill of the business to the company for consideration, as its evaluation and payment can have tax implications, such as Capital Gains Tax. Typically an hour’s discussion with an accountant at this point will pay for itself.
Partnerships and LLPs briefly
If you start a business with someone else, you may consider forming a partnership. In an ordinary partnership, all owners of a business are personally liable for the business’s debts and losses. They also complete a Self Assessment tax return and pay tax on their share of the profits from the business. A partnership tax return is completed by a nominated partner. A limited liability partnership (LLP) is a separate legal entity registered at Companies House which offers its members the benefit of limited liability whilst they are treated as self-employed in respect of their share of the profits of the LLP. Many professional firms are set up as LLPs. Whatever structure of business you choose to set up, it is sensible to draw up a written agreement between the owners of a business which outlines the owners’ agreement on issues such as distributions, decision making and the circumstances in which an owner may leave the business.
When to get professional advice
While many simple businesses with modest profits set up structures themselves using the GOV.UK guidance, it can be worth paying for advice when, for example, profits are heading above the higher rate threshold, you need to retain funds in the business, you are taking on debt or new premises, others are involved in the business, or you are migrating an existing trade into a company structure. A qualified accountant can then model your actual figures and a solicitor can assist with shareholder or partnership agreements. You can start to get free help from the government’s Business Support service and your local growth hub.
Checklist: choosing your structure
- Estimate this year’s profit and next year’s, honestly.
- Decide how much of that profit you need to take out to live on.
- List the risks: contracts, customer claims, premises, borrowing, staff.
- Ask your main clients whether they require a limited company.
- Price the admin: accountant’s fees for a sole trader versus a company.
- Check whether anyone else will own part of the business now or later.
- Run the tax sums on current rates, not on last year’s rule of thumb.
- Learn the basic competition rules before you agree anything with a rival business.
- Register with HMRC or Companies House and diarise every deadline.
- Review the structure every year or two, because a business that looks settled is still changing.
Sole trader vs limited company: FAQ
Is it cheaper to be a sole trader or a limited company?
The rates for 2026 to 2027 can often leave a sole trader marginally better off where all of the profit from the business is paid out to one owner, particularly once the cost of accountancy has been taken into account. However, when profits are retained within the business or when pension contributions and other planning are used, a company would generally be more beneficial. It is essential to carry out your own calculations before deciding.
Can I be employed and a sole trader at the same time?
Yes. Many people run businesses in addition to their salaried employment and here it is vital to understand that your earnings from employment and your trading profits are added together for Income Tax, so the side business could be charged at a higher rate than you expect.
Do I need an accountant for a limited company?
There is no legal requirement for accounts to be prepared by an accountant, but as accounts and tax returns have formal rules and penalties for error, most small company directors use one, though they remain liable in respect of the accounts.
Does a limited company protect my house?
A company protects your personal assets from the ordinary trading debts of the company, but does leave you personally liable for debts such as those you have guaranteed personally, and in other specific circumstances such as trading while insolvent as a director of the company.
Can I change from sole trader to limited company later?
Yes, and that is the more common direction. You set up the company, transfer the trade to it and tell HMRC that your self-employment has ended. Get advice on how the assets and goodwill are moved across.
