When it comes to starting a business in the UK, one of the first decisions you have to make is whether to start as a sole trader or a limited company.
Both of these company formation types have their own unique advantages (which we’ll recap below), but for the majority of small business owners, the freedom and ease of being a sole trader wins out – at least in the beginning.
As your company grows and evolves, you might benefit more from being a limited company. But this isn’t a decision to take lightly – it’s relatively easy to transform from a sole trader to a limited company, but this process isn’t so easily reversed. To help make this decision easier, we’ve put together this guide on when to go from a sole trader to a limited company.
A quick recap: Sole traders vs limited companies
Before we get into the nitty-gritty, let us go over a few core components and differences between a sole trader and a limited company.
A sole trader is a business that’s owned and run by one person. Hence, the ‘sole’ part of the name. Sole traders are self-employed, meaning they get to enjoy a lot of bureaucratic freedom over limited companies, with less paperwork and red tape to jump through.
A limited company is a registered company that is owned by shareholders. It doesn’t matter if there are 1 or 100 shareholders, the key part here is that the company has shares – and therefore parts of the business can be owned or sold.
Because limited companies are registered companies, they offer less personal financial risk than sole traders, as the company is classed as its own legal entity. That means any debt accumulated by a limited company belongs to the company, not to you. Limited companies can also get better tax breaks, increased financial backing, and seem more professional, which in turn could get you better clients and investments.
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When to go from a sole trader to a limited company: the 5 key questions you need to answer
Going from a sole trader to a limited company can mean better tax breaks, a chance to earn more high-profile clients or get better investment for your growth. If you’re considering making the change, ask yourself these 5 questions to see if now is the right time to change from a sole trader to a limited company.
1. Are you making high profits?
A key difference between being a sole trader and a limited company is the tax that you’ll pay, which can make a huge difference to your take-home pay. So it depends on how well your company is performing.
Generally speaking, if you’re making more than £15,500 a year on profits, you might benefit from becoming a limited company. This is because you’ll pay a fixed flat tax rate on your profits that is lower than the rate of personal tax you’ll have to pay as part of your self-assessment tax return.
Let’s show this with an example. Let’s say your company makes around £60,000 a year. [Note: figures and rates are correct for tax year 2024/25.]
When paying tax as a sole trader, you’re allowed a personal tax-free allowance of £12,570 a year. Anything over that amount is split into three different tax bands of:
| Earnings | Tax Band |
| £12,571-£50,270 | Basic Income Tax rate at 20% |
| £50,271-£125,140 | Higher Income Tax rate at 40% |
| £125,140+ | Additional Income Tax rate at 45% |
Earning £50,000 puts you in the higher Income Tax bracket of 40%. Of your £60,000 a year, the first £12,570 is tax-free. The remaining £37,430 is taxed at 40%, which means you’ll be paying £14,972 in income tax.
As of 2024, you need to pay Class 4 National Insurance contributions as a sole trader. Previously, you had to pay a fixed weekly charge for Class 2, but has been recently removed to give sole traders and small businesses a tax break and help grow the economy.
Class 4 contributions are also calculated on a rate basis like income tax. The first £12,570 is tax-free, while:
- Income between £12,570 and £50,270 is charged at a higher rate of 6%. (recently reduced from 9%!)
- Any other profits over £50,270 are charged at just a 2% rate.
Earning £60,000 a year as a sole trader would amount to:
- £14,972 in income tax
- £748.60 in Class 4 National Insurance contributions.
That means a sole trader earning £60,000 a year will pay a total of £15,720.60 in tax, making their take-home pay £44,279.40.
Now, let’s say that the same business was a limited company earning £60,000 a year. Limited companies don’t pay any income tax or national insurance but instead pay corporation tax on their profits.
For profits under £50,000 companies pay the small profits rate, which is at 19%. Companies with a turn-over of £250,000 and more pay the main rate at 25%.
Businesses that earn between £50,000 and £250,000 pay the main rate (25%) minus Marginal Relief.
So if you’ve earned £60,000 in profits, you’ll only need to pay £12,150 in tax, leaving £47,850 in profit. That’s over 3 grand more than you would have left as a sole trader.
With a limited company, you can also set up a salary to pay yourself a fixed monthly amount, or pay yourself through dividends, allowing you more flexible options to keep more of your hard-earned profits.
If all of this sounds like a maths nightmare, then it might be best to speak to your accountant about getting the best deal for you. Not got an accountant? Take a look at our reviews of the best online accountants to get started today.
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2. Are you planning to sell?
Some companies you want to run to the very end. Other times, you want to get a company on its feet, flip for a profit, and put the money into your next venture.
If you’re one of the people who are thinking about selling, then you’ll want to change from a sole trader to a limited company in order to sell up shop. That’s because as a sole trader, the company doesn’t exist as its own legal entity. The company is you, and you cannot sell yourself.
However, as a limited company, the company you built exists on its own without you. It will also gain shares, allowing you to sell and transfer all of the shares onto a new owner.
3. Do you need more investment?
If you’re planning to grow or scale up your business and need some more investment or funds to make it happen, this might be the sign you’ve been waiting for to convert from a sole trader into a limited company.
As a limited company, you are more likely to be accepted for bank loans or other sources of funding because the company counts as its own legal entity. That means that people are able to invest directly into your business, rather than take out personal loans in your name.
Psst, did you know that businesses with a business plan were also 2x more likely to get investments or secure loans than those without? Make sure that you’re giving your company its best shot by following our step-by-step guide on how to write a business plan before you go in for that investment. It will pay off, trust us.
Because a limited company is made up of shares, you can also sell or assign shares as another way to gain investment and funding. But it’s worth remembering that selling shares means that this person is now involved with your business and will have a say in important decisions – which might not be the right choice for you if you want to keep total authority over your business.
Find out more about how you can assign shares in a limited company with our in-depth guide here.
4. Are you planning to attract new high-profile clients?
Being a sole trader has a lot of advantages, including making you seem like a small, friendly and local company. If you’re offering local plumbing services, this reputation is a great bonus to have.
However, if you’re looking to sell your product or services to more high-profile clients, being a sole trader might make your business look inexperienced or too small to handle the job. First impressions are important, so if you’re looking to scale up your client list and attract a new type of audience, changing from a sole trader to a limited company could give you that extra bit of prestige to stand out from the crowd.
If this is going to be a regular occurrence for your company, it could benefit you to switch over. However, if this is a one-off, it might not be worth the red tape just to satisfy one client.
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5. Are you planning to work on higher-profile projects?
As well as offering a more professional look to your clients, being a limited company allows you to take out more advanced forms of public liability cover and insurance, which may be requested on certain contracts before you can sign off on a project.
Now, there’s nothing stopping you from taking out these insurances as a sole trader (and we’d recommend always getting these types of insurances!) but you might get better deals, rates, and cover as a limited company.
Taking out these policies shouldn’t be the only factor in deciding when the right time to switch over from a sole trader to a limited company though, so just bear it in mind with the rest of these key questions. If you’ve answered yes to one or more of the others, it looks like it might be time to change.
How to change from a sole trader to a limited company
Right, so now we’ve decided it’s the right time to change from a sole trader to a limited company, let’s talk about the steps involved to make this official. If you want a more detailed rundown, you might want to check out our full guide to changing from a sole trader to a limited company here.
Generally speaking, the whole progress can be done in 4 steps.
- Form your limited company. (We’ll expand on this below).
- Get in touch with HMRC to inform them of the change.
- De-register as self-employed and stop your National Insurance payments.
- Let your accountant know and keep your records up to date!
Before you get hung up on step one, we’d like to remind you that you don’t have to actually carry out this step yourself. If you don’t fancy filling out paperwork, you can get a company formation agent to complete this entire process for you.
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And when you’ve got so much else on your plate running a business, using company formation agents is a perfect way to relieve stress that you don’t need. To help you find the right agent, we’ve tested and reviewed all of the top company formation agents out there to make finding the right one for your business a breeze.
What else do I need to know as a limited company?
Setting up your business as a limited company rather than a sole trader means that you need to be aware of a few differences in responsibility, which we’ll quickly list below.
Create a business bank account
If you haven’t already done so, one of these is to ensure that you’ve set up a separate business bank account.
Although you can use your personal bank account while you’re a sole trader (as you are the business), a limited company is its own entity. This means your company needs a bank account, and all your finances must be in the business’s name. There’s a strict divide between business and personal here, and you don’t want to blur the lines.
Asset transfer
If you have any business assets that you bought when working as a sole trader, you can transfer them to your business when you become a limited company. However – before doing this we’d always recommend speaking to an accountant first as there are different tax implications depending on what assets you want to transfer.
IR35
IR35 is legislation brought in to prevent tax avoidance by classifying employees as contractors. As a sole trader, you don’t need to worry about IR35. But as a limited company, you need to be careful, particularly if you’re working with contractors or freelancers in your business.
That means keeping clear records and contracts for all your workers (and double-checking that they do not receive any employee benefits), creating Status Determination Statements, and providing evidence of all classifications.
Not following IR35 rules will result in a long and stressful HMRC investigation, as well as some hefty fines and penalties for wrongly classifying employees and an extra 25% tax on top of your final bill (ouch).
You can find out more about IR35 and how to not get caught out by the legislation here.
Allowable expenses
Both limited companies and sole traders can claim allowable expenses when they are “wholly, exclusively and necessary” for business purposes. The allowable expenses are generally the same, as you can still claim for things like travel, utilities, and insurance.
One key difference is how allowable expenses are claimed for a limited company. Here, you have two options:
- Pay for the expense directly from the company’s business bank account – then keep records to claim back and lower your tax bill when you submit your annual returns.
- Pay the expense personally from your own account, which then becomes a reimbursed expense. You’ll submit this expense to your company, who will then pay you back, before adding both the expense and reimbursement to your accounting records.
Top tip: accounting software will make tracking these expenses much quicker and easier.
Payroll and wages
When your business becomes a limited company, you and your company will be separate legal entities. That means your finances are now separated – you can’t just take the company’s profits as your profits. Instead, you will have to pay yourself through alternative means.
The most common way to pay yourself through a limited company is a combination of a waged salary (a set amount you get each month) and dividends (which pay you a share of the company’s profit).
Even if you are the only employee of your limited company, you will still need to set up payroll and your wages through the PAYE system.
Update your insurance
Any business insurance you have as a sole trader must be updated, and put in the limited company’s name instead of your own. This might mean changing your policies – and taking out extra cover.
For example, if you don’t already have it, you will be required to take out Employers’ Liability Insurance as you are now employing yourself. You might also want to think about Directors and Offices Insurance, which will give you extra financial protection for decisions or actions taken within the scope of their regular duties.
One last note…
In this guide we’ve covered when the right time to change from a sole trader to a limited company is, depending on where your company is at right now.
But one important thing to note is, whether you’re a sole trader or a limited company, to make sure that you’re completing your returns and taxes accurate and on time. The last thing you need while deciding the future of your business is to be investigated by the HMRC, so make sure that you get your books in order before you make the switch.
Other than talking to your accountant, it’s worth investing in online accounting software to keep accurate records and make sure that your books are how they should be. Find the best accounting software for your budget and needs with our reviews of the best accounting software on the market here.
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