Self-Employed vs Limited Company: What Are the Differences between Being Self-Employed and Trading as a Limited Company?

There are many things to think about when you're starting your own business. What will your business name be? What services or products will you offer? How will you market yourself? How will you handle accounting and taxes?
But something a lot of people don't think about when starting a business is the legal structure. While there are several options, most business owners choose to become a sole trader or a limited company. In the UK, there are 3.2 million sole traders and 2 million registered limited companies , so both structures are popular.
But choosing a business structure can be tricky, especially if it’s your first business. In this guide, we'll examine the key differences between these two options. By understanding the pros and cons of both, you can make an informed decision about what's best for you and your business.

The Importance of Choosing the Right Legal Business Structure

The legal structure of your business is likely to be one of the most important decisions you make if you choose to work for yourself and set up your own company. But what is the difference between being self-employed and trading as a limited company? And does this have any impact on the tax you pay?
You must decide on the correct structure for your business, as doing so incorrectly could land you a tax bill far greater than it should be. It will also affect your company registration. If you choose to be a sole trader, you only need to register with HMRC for self-assessment tax. But if you become a limited company, you’ll need to register your business with Companies House and HMRC for tax. 
Whether or not you decide to trade as a sole trader or limited company will depend on various factors, including:

• Your tax affairs

• The ownership of your business

• Your plan for business expansion

• Liability

• Your target customers.

Essentially, setting up a limited company means your company's finances are completely separate from your own. If you are self-employed as a sole trader, you are financially liable for the success or failure of your business. This means that assets such as your savings, house and car are at risk if your business fails or you fall into debt and cannot keep up with payments. 
But if you set up a limited company, you have limited liability . This means your finances are treated as entirely separate from your business's. So, the corporate director of a limited company isn't held personally responsible for the company's financial failings.

What Does It Mean If You Are Self-Employed or Sole Trader?

Being self-employed means you own your business and work for yourself. No one else owns your company, and you do not have shareholders or officers. Being self-employed means you’re in total control of your business. Self-employment is also known as being a sole trader or sole proprietor. 
Your responsibilities as a sole trader include: 

• Registering self-assessment tax returns

• Paying your tax by 31st January each year

• Keeping accurate records of your business’s sales and expenses

• Complying with HMRC’s VAT rules

• Choosing a business name that complies with HMRC’s rules.

Advantages of Being a Sole Trader

First, registering as a sole trader means you have complete control over your business. You get to make all the decisions, from your products or services to how you run your operation. This can be liberating and empowering.
Secondly, as a sole trader, you get to keep all your business profits. This can be a significant advantage if your business is successful. 
Higher taxation is often seen as a negative side to self-employment. But self-employed people have more freedom to extract profits from their business without immediate tax implications. The structure of a limited company restricts directors from doing this so easily.
Finally, sole traders often have lower overheads than larger businesses, which means they can be more profitable. All in all, being a sole trader can be a great way to build a successful business.

Disadvantages of Being a Sole Trader

There are also some disadvantages to consider before deciding to go it alone as a sole trader.
One of the main drawbacks of being a sole trader  is that you are personally responsible for all of the debts and losses incurred by your business. If your company struggles financially or legal action is taken against you, you are personally liable and have to pay costs from your personal finances — unlike a limited company, which has limited liability protection. 
If you make a profit as a self-employed person, you still have to pay tax like a limited company, but the amount you pay will differ. You will pay income tax as an individual rather than corporation tax as a company. You also have to pay class two and class four National Insurance as a self-employed individual — usually more than a limited company director. 
As a sole trader, you may also find raising capital to grow your business challenging. You will need to convince potential investors and banks that you are a reasonable risk and that your business is legitimate.
Finally, you may have difficulty taking time off, as there will be no one else to cover for you if you need to take a holiday or take time off for other commitments. 
Overall, being a sole trader can be a great way to start your own business, but it’s essential to be aware of the risks involved before taking the plunge.
Read our complete guide on how to register as self-employed. 

What Is a Limited Company?

A limited company is a separate legal entity from its shareholders and directors. If you are a self-employed sole trader , such as a freelancer, you are your business, and the two become one identity. 
A limited company's identity is separate from those who own and operate it, and the director cannot be held personally liable for the company's financial failings. A director can, however, be held personally liable if they commit fraud or breach health and safety legislation.
The responsibilities of a limited company director include: 

• Registering your business with Companies House

• Keeping accounting records

• Maintaining records and reporting company changes

• Paying corporation tax

• Filing an annual confirmation statement

• Keeping the company’s register of People with Significant Control (PSCs) up to date.

If you are the founder of a limited company, you don't “own” the business. The ownership is based on shares and stakeholders . You can own a stake in a company — whether it’s 10% or 100% — and can hold a proportion of a company based on share ownership capital rights.
If you create a limited company , you are also not your own boss like a self-employed sole trader. Instead, you are a director or company officer, reporting to shareholders and stakeholders with interests within the company. If you are a managing director of a limited company, you also don't have “employee” status and — by law — do not have automatic entitlements to benefits such as the national minimum wage .
A limited company has to pay tax on all its taxable profits. It pays Corporation Tax, which is far lower than personal Income Tax. However, all employees and directors must be signed up to PAYE and National Insurance contributions . Corporation Tax is charged at a rate of 19%. Company directors pay income tax based on their company salary. 
To take advantage of limited company tax benefits, some directors choose to pay themselves a lower salary so they can leave profits in their business rather than paying tax on them. This also lowers National Insurance contributions. Directors can still pay themselves cash in the form of dividends should they wish to.

Advantages of Being a Limited Company Director

There are a lot of advantages to being a limited company director . For one thing, you have a lot of flexibility regarding how you structure your business. You can choose to have shareholders or be the sole shareholder. If you have shareholders, you can offer them different shares, such as equity or preference shares.
You also have a lot of control over your company. You get to decide who the directors are, the company's name and where the registered office is. You also get to choose what sort of activities the company carries out.
One of the biggest advantages is that, as director, you're not personally responsible for any debts or legal issues the company faces. So, if the company goes into debt, creditors can't come after your personal assets to repay the debts.
Finally, being a limited company director can help improve your personal credit rating. This is because, as a director, you're seen as more financially responsible than someone who isn't a director. And having a good credit rating can help you get better deals on things like mortgages and loans.

Disadvantages of Being a Limited Company Director

There are also some disadvantages to consider before setting up a limited company. Firstly, limited companies tend to have more complex structures than sole proprietorships or partnerships, making them more expensive to set up and maintain.
Additionally, directors may have less control over the day-to-day operations of a limited company than they would in a sole proprietorship or partnership if you sell shares to investors in exchange for their capital. This means that, unlike in a sole proprietorship or partnership, you don't own the company outright — the shareholders do. And as such, they have certain rights and powers regarding how the company is run. 
Finally, limited companies must file annual financial reports with Companies House , which can be time-consuming and expensive. For the most part, limited companies hire accountants to handle this, which can be costly. 
While there are some disadvantages to setting up a limited company, it’s still a great way to start a business, protect personal assets and manage risk.
Read our complete guide to setting up a limited company. 

Self-Employed vs Limited Company: The Key Differences Explained

While we've covered what it means to be self-employed or a limited company and looked at their advantages and disadvantages, you might still be unsure which option is best for your business. If you've never run your own company, making such an important decision can be a bit daunting.
That's why we've broken the differences down below. This makes it easy for you to see how your choice will affect how you run your business. Some of these have already been covered, but having them in one place is handy, so you can come back and find the differences easily.

Employment Status

As a sole trader, your employment status is self-employed, which means you can't be an employee of your business. 
As a director of a limited company, you are an officer of the company, but that doesn't automatically mean you're an employee of the business. But when it comes to tax and national insurance contributions, most limited company directors are treated as employees.

Tax

Tax is a big difference between being a sole trader or a limited company. Sole trader tax is not hugely different from employee tax as you pay income tax on all your taxable profits. However, as a sole trader, you’ll pay both Class 2 and 4 National Insurance contributions rather than Class 1. 
Limited company tax is a lot different. As a company, you will pay corporation tax on your taxable profits. As a company officer, you’ll also pay income tax and National Insurance in much the same way as an employee. Being a limited company is more tax efficient for business owners, and tax benefits and incentives are available.

VAT

Sole traders and limited companies have the same rules when it comes to VAT. If a business earns more than the £85,000 VAT threshold, it must register for VAT and charge it on its products or services if applicable.

Losses

Hopefully, you'll never need to worry about losses, but here's how they work if you do. As a sole trader, you can offset your losses against any other personal income. This is quite different for limited companies. Limited companies can offset trading losses against other company income, but directors cannot offset losses with personal income.

Borrowing

If you want to borrow money from your company as a sole trader, you're free to do so. As there's no legal distinction between you and your business, you're free to borrow from your business bank account.
For limited companies, it's a little more complicated. Directors are permitted to borrow from their company, but there are rules set out in the Companies Act 2006 . These rules include a 32.5% tax charge if you do not repay the loan within nine months of year-end. We recommend speaking to a financial advisor or tax expert before borrowing from a limited company.

Pensions

Unfortunately, you are only eligible for a personal pension as a sole trader. Limited company directors have more pension options available. You are eligible to join your company pension scheme, which will probably be more generous than a personal pension. 
Share Incentive Plans (SIPs) and Self-Administered Schemes (SAS) are also available to directors. It's worth noting, though, that you'll be responsible for ensuring any employees have the option of enrolling in your pension scheme.

Insolvency

Insolvency is another big difference between sole traders and limited companies. If your business fails as a sole trader, you are personally liable for its debts. This can put your personal assets at risk and can lead to bankruptcy.
As the director of a limited company , you have limited liability if your company fails. This means you'll only need to pay the amount unpaid on your shares or if you've made a personal guarantee for any company borrowing. It's important to note you may be personally liable if you continue trading when your company is insolvent.

Legal Disputes

Legal disputes can arise for various reasons, and it's essential to understand your legal liability. As a sole trader, you will face any legal disputes personally unless you have the appropriate insurance. 
Most of the time, for limited companies, it's the company that is legally liable and not the company director. But in cases where a director has committed fraud or specific offences, they may be personally responsible.

Accounts

As a sole trader, there's no requirement for you to prepare tax accounts unless you are registered for VAT. For obvious reasons, keeping accurate accounts as a sole trader is a good idea, as you'll still need to file your self-assessment tax return .
Limited companies are required to prepare annual accounts under the provisions of the Companies Act 2006. These accounts must be prepared per accounting standards and submitted online. If you're a limited company, we'd recommend hiring an accountant to handle your accounts.

Expenses

Expenses are a great way to offset your expenditure and ensure you pay the right amount of tax. As a sole trader, you can claim expenses used exclusively for your business. You can also claim a percentage of an expense related to your business, such as household bills if you work from home.
For limited companies, expenses work in much the same way. A company can claim expenses if they are solely for the business. If a director incurs private expenses through the company, they can be considered earnings.

Moving from Self-Employed to a Limited Company

As you can see, there's a lot to consider when you start a business and choose a legal structure. The good news is that although it's an important decision, it's not set in stone. If you decide to start your business as a sole trader, there's nothing to stop you from becoming a limited company later. In fact, this is a route many business owners choose.
Many business owners start as sole traders and set up a limited company once they've grown the business. Switching from sole trader to a limited company is quick and easy, especially if you use the services of a formations agent.
Are you planning to become a sole trader or limited company? Mint Formations can help you set up as a sole trader or register a limited company - compare the company formation packages we offer. If you have questions about starting your business, contact the Mint Formations team today. 

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