If you are starting a business in the UK, one of the first big decisions you will make is how to set it up legally. For most new business owners, the choice comes down to two options: register as a sole trader or form a limited company.
Both are perfectly legitimate, and there is no single right answer. What works well for a freelance designer earning £25,000 a year might be a poor fit for a growing online shop making £150,000. The right structure depends on your profits, your plans, and how much paperwork you are happy to handle.
This guide walks you through both options in plain language: what they are, how they are taxed, what they cost to run, and when each one makes sense. We use the tax rates and rules that apply in the 2026/27 tax year, so you can decide with confidence.
What Does It Mean to Be a Sole Trader in the UK?
A sole trader is the simplest way to run a business in the UK. You and the business are the same legal person — there is no separate company. You keep all the profits after tax, and you are personally responsible for the business, including any debts it takes on.
How You Set Up as a Sole Trader
Getting started is free and quick. You register as a sole trader on GOV.UK by signing up for Self Assessment with HMRC. You need to register if you earned more than £1,000 from self-employment in a tax year (the trading allowance covers anything under that). After registering, HMRC sends you a Unique Taxpayer Reference (UTR), and you file a Self Assessment tax return every year.
You can trade under your own name or pick a business name (you cannot use “Ltd” or “Limited” in it). No special bank account is required by law, although a separate account makes your records much easier to manage.
How a Sole Trader Is Taxed
You pay Income Tax and National Insurance on your profits (income minus allowable business expenses), not on your total turnover. For the 2026/27 tax year:
- Income Tax: you get the standard personal allowance of £12,570, then pay 20% on profits up to the higher-rate threshold, 40% above that, and 45% on the highest earnings.
- National Insurance: you pay Class 4 contributions at 6% on profits between £12,570 and £50,270, and 2% on profits above £50,270. If your profits reach £7,105, you are treated as having paid Class 2 contributions, which protects your State Pension record.
You must register for VAT if your taxable turnover goes above £90,000 in a 12-month period; below that it is optional.
The Main Trade-Off: Unlimited Liability
The big downside of being a sole trader is unlimited liability. If the business runs up debts it cannot pay, your personal savings, car, or even your home can be at risk. For low-risk service businesses this rarely matters, but if you take on credit, sign leases, or sell products that could cause injury, it is a real consideration.
What Does It Mean to Run a Limited Company?
A limited company is a separate legal entity from you. The company owns the business’s assets and owes its debts — your personal finances are normally protected. That separation is the meaning of “limited”: your liability is limited to what you put in.
How You Set Up a Limited Company
You form a company by registering it with Companies House, which costs £50 when you do it online. You will need at least one director, at least one shareholder, a company name, a registered office address, and a statement of capital. If you would like the full walkthrough, our guide on how to register a limited company covers each step in detail.
Once the company is running, you must also register it for Corporation Tax with HMRC within three months of starting to trade.
How a Limited Company Is Taxed
The company pays Corporation Tax on its profits. For 2026/27 the rates are:
- 19% on profits up to £50,000 (the small profits rate)
- 25% on profits over £250,000 (the main rate)
- Marginal relief applies between £50,000 and £250,000, smoothing the jump between the two rates
You as a director typically pay yourself through a mix of salary and dividends. Salary is deductible from the company’s profits, and dividends are paid out of what is left after Corporation Tax. Many small company directors take a modest salary (up to the National Insurance threshold) and the rest as dividends, which often works out more tax-efficient than taking everything as a sole trader’s income — but the rules have tightened in recent years, so the gap is smaller than it used to be.
The Main Trade-Off: Paperwork and Costs
A limited company comes with ongoing admin. You must file annual accounts and a confirmation statement with Companies House, keep full company records for six years, and file a Corporation Tax return with HMRC. You will also need payroll if you pay yourself a salary. Most owners either pay an accountant (typically several hundred pounds a year) or invest time in doing it themselves.
Sole Trader vs Limited Company: The Key Differences Side by Side
| Sole Trader | Limited Company | |
|---|---|---|
| Legal status | You and the business are one | Separate legal entity |
| Liability | Unlimited, personal assets at risk | Limited, personal assets usually protected |
| Setup cost | Free (HMRC registration) | £50 online with Companies House |
| Setup speed | Same day in most cases | Usually within 24 hours |
| Main tax | Income Tax + Class 4 NICs on profits | Corporation Tax (19–25%), then tax on dividends/salary |
| Tax at £30,000 profit | roughly £4,000 (after allowances) | roughly £5,700 Corporation Tax before personal tax on extraction |
| Tax at £80,000 profit | roughly £19,000 | roughly £15,200 Corporation Tax + tax on dividends/salary |
| Paperwork | One Self Assessment return a year | Accounts, confirmation statement, Corporation Tax return, payroll |
| Business name | Not protected | Name registered and protected at Companies House |
| Professional image | Fine for freelancers and small services | Often looks more credible to lenders, suppliers and clients |
The tax figures above are rough illustrations for 2026/27 using standard allowances and rates, and before any personal tax on dividends. Your own situation may differ — this is not tax advice.
When a Sole Trader Makes More Sense
Being a sole trader is usually the better choice if:
- You are just starting out. It is free, fast, and you can always incorporate later.
- Your profits are modest. Under roughly £40,000–£50,000 a year, the tax difference between the two structures is small — sometimes the sole trader route even wins because of simplicity and the trading allowance.
- You do little paperwork by choice. One tax return a year versus a full set of company filings is a big difference in time and accountant fees.
- Your business is low risk. If you sell services rather than products, hold no debt, and work alone, unlimited liability is less of a worry.
- You want to test an idea. Many people start as sole traders, prove the business works, and form a company once profits justify the extra admin.
When a Limited Company Makes More Sense
Forming a limited company is usually worth it if:
- Your profits are growing. Once you consistently earn well above £50,000, the 19% small profits rate plus tax-efficient dividend extraction usually beats Income Tax and Class 4 NICs.
- You want to reinvest. Money kept inside the company for future investment is taxed at Corporation Tax rates, which is attractive if you are growing.
- You want limited liability. If the business borrows money, signs leases, employs staff, or operates in a risky industry, protecting your personal assets matters.
- You want to look bigger than you are. Some clients, agencies, and lenders prefer — or insist on — dealing with a registered company.
- You plan to raise investment or sell. Investors and buyers almost always prefer shares in a company to a sole trader’s business, which is harder to transfer.
Can You Switch From Sole Trader to Limited Company Later?
Yes — and many people do. A common path is to start as a sole trader while profits are small, then incorporate once the business is established. When you switch, you register the new company with Companies House, tell HMRC you are no longer self-employed, and transfer the business’s assets into the company.
There are some tax points to handle when you transfer assets (for example, potential Capital Gains Tax and Stamp Duty considerations), so it is worth getting professional advice before the switch. Some owners even incorporate retrospectively at the start of a tax year to keep the paperwork clean.
Frequently Asked Questions
Is it better to be a sole trader or a limited company in the UK?
Neither is automatically better — it depends on your profits and plans. Sole trader is simpler and cheaper, ideal for beginners and lower incomes. A limited company protects your personal assets and is usually more tax-efficient once profits climb well above £50,000 a year.
How much tax do you pay as a sole trader?
You pay Income Tax and Class 4 National Insurance on your profits. For 2026/27, after the £12,570 personal allowance you pay 20% Income Tax and 6% Class 4 NICs up to £50,270 of profit, with higher rates above that. You pay through a yearly Self Assessment return.
What is the corporation tax rate for small companies?
In 2026/27, UK companies pay 19% Corporation Tax on profits up to £50,000. The 25% main rate applies above £250,000, with marginal relief smoothing the rates in between.
Can I be employed and a sole trader at the same time?
Yes. Many people run a side business alongside a job. You stay on PAYE for your employment and pay Income Tax and Class 4 NICs on your self-employed profits through Self Assessment. Keep the two income streams clearly separated in your records.
Conclusion
Choosing between a sole trader and a limited company is really a question of where your business is today and where you want it to go. Start simple if you are new, keep costs down, and focus your energy on getting customers. When profits grow, risks increase, or you want to reinvest and look more professional, a limited company becomes the stronger option.
The good news is that the decision is not permanent. Plenty of successful UK businesses began life as sole traders and incorporated when the time was right. Whatever you choose, keep your records tidy, meet HMRC’s deadlines, and revisit the question once a year as your numbers change.
