When To Go From A Sole Trader To A Limited Company?

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. 

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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, 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 are 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. 

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: 

EarningsTax Band
£12,571-£50,270Basic Income Tax rate at 20%
£50,271-£150,000Higher Income Tax rate at 40% 
£150,000+Additional Income Tax rate at 45% 

Earning £60,000 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 £47,430 is taxed at 40%, which means you’ll be paying £18,972 in income tax. 

In addition, as a sole trader, you’ll need to pay Class 2 and 4 National Insurance contributions. Class 2 contributions are a fixed charge of £3.05 per week for any business that makes over £6,515 per annum, equating to £158.60 for the year. Class 4 contributions would be charged at 2% of profits over £50,270, bringing this total to £1,200. 

A sole trader earning £60,000 a year will pay a total of £18,972 in tax and £1358.60 in National Insurance contributions, making their take-home pay £39,669.40. 

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 at a fixed rate of 19%. 

So if you’ve earnt £60,000 in profits, you’ll only need to pay £11,400 in tax, leaving £48,600 in profit. That’s nearly 10 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 math 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? 

If your plan is to attract high-profile clients, probably this is the time when to go from a sole trader to a limited company.

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. 

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. 

  1. Form your limited company. (We’ll expand on this below). 
  2. Get in touch with HMRC to inform them of the change.
  3. De-register as self-employed and stop your National Insurance payments. 
  4. 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. 

Our recommended company formation agents:

Formation AgentCheapest PackageAdd On ServicesOur RatingReviewOfficial Site
1st Formations£12.99Excellent
Read ReviewVisit Website
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ANNA ReviewFREEAverage
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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. 

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.

Our recommended accounting software:

Accounting SoftwareCheapest PackageEase Of UseOur RatingReviewOfficial Site
FreeAgent reviews£19/moExcellent
Read ReviewVisit Website
ANNA ReviewFREEOutstanding
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Quickbooks Reviews£12/moExcellent
Read ReviewVisit Website
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Business4Beginners has been advising new businesses owners since 2013. The founder, Paul Bryant, has created, grown and sold several successful businesses and remains the editor and fact-checker of all content published on the site.
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