Are you unsure of whether to start your freelancing business as a sole trader or a limited company? Perhaps you are currently operating as a sole trader, and are considering whether it’s still the right structure for where your business is at now?

The choice is yours, and freelancers don’t need to register as one particular structure over another, but it can be difficult to work out which option is best, especially if you are new to freelancing.

Different business structures can have a big impact on how you operate and the way you pay tax, so it’s essential that you fully understand the potential benefits and implications of your decision.

While we always recommend seeking professional advice specific to your personal circumstances, here’s an overview of how limited companies and sole traders operate.

Freelancing as a sole trader

The natural step for most freelancers is to register with HMRC as a sole trader, and make Self Assessment tax submissions to tell them about their earnings. It’s less formal, but this also means there’s no legal distinction between you and the business.

In one respect this makes things like paying yourself a bit easier, because you can just keep any profits, but this also means you’ll pay tax on those profits even if you don’t take them out of the business.

The other side effect is that it also makes you personally responsible for running your business. Any liabilities, losses or debts all belong firmly to you, and not just to the business.

Can sole traders hire staff?

Despite the name, you can hire staff as a sole trader, so if your freelance work really takes off you can employ someone else (or outsource it out to another freelancer).

Can I be a sole trader freelancer and still work for my boss?

Don’t worry, sole traders are allowed to do self-employed freelance work as well as working for an employer – in fact it’s pretty common! And no, your boss doesn’t have to know that you’re working on a side hustle.

It’s also worth noting that the trading allowance means you can earn up to £1,000 of self-employed income in a tax year before you need to register with HMRC.

Pros of freelancing as a sole trader

• A straightforward Self Assessment taxation system
• Flexibility to incorporate the business as a limited company at a later date if you want to
• Greater privacy as your name and details are not published by Companies House
• Cost of compliance and tax returns are usually cheaper
• Cheaper to close the business

Considerations for freelance sole traders

As the business grows over time, there may be a point when operating as a sole trader limits the potential of the business, depending on the sort of projects you deal with. So while it’s easy to become a sole trader and also to stop, it can have its drawbacks.

Another common issue is tax efficiency. Sole traders pay income tax on all of their profits, even if they don’t actually withdraw them from the business for personal use. Limited companies pay Corporation Tax, which is lower than income tax, and then you’ll pay personal tax on any income that you pay to yourself. So, depending on how much you earn, it can be more tax efficient to operate as a limited company.

The other common consideration of being a sole trader is personal liability. If your business were to incur debts or losses, then you would be solely responsible for these, not the business.

Freelancing as a limited company

Setting up a limited company (known as incorporation) means you’re creating an organisation which is totally separate to you personally in terms of its legal identity and financial activity.

Some freelancers prefer this because it means the business is separate to them personally, which means any debts or liabilities won’t be a threat to their personal assets.

Limited companies do need to register with Companies House, and the details of all key members of the business, including directors, will be publicly available. The process is a bit more formal, and this has an impact on tax and reporting requirements.

If my company is a separate entity, how do I pay myself?

Freelancing as a limited company rather than as a sole trader means the way you pay yourself also changes. Most of the time it’s more tax efficient to pay yourself a combination of a salary, and then take dividends (which incur tax at a lower rate).

The flipside of this is the extra admin.

• The limited company must submit a Company Tax Return and pay Corporation Tax.
• Then, if you take a salary, your company must register as an employer, and pay you through PAYE.
• If you take dividends as well, then you’ll also need to register for Self Assessment too, so you can report this income and pay tax on it.

If my company is a separate entity, how do I pay myself?

• Easy and cheap to set up
• Limited liability, so your personal assets have more protection
• More options for tax efficiency
• The ability to bring in multiple shareholders or directors
• Can add business credibility
• Your company’s legal name will be protected, making it harder for other businesses to pretend to be you

Considerations

As you might expect with a limited company, there is going to be more administration to think about. It’s also worth thinking about your ongoing freelancing plans.

We say this because dissolving a limited company is not an easy process, and you can’t just deregister and walk away in quite the same way that you can as a sole trader. If you wanted to close the business altogether then the winding up process is a bit more involved.

Existing sole traders looking to switch to a limited company should also be aware that some mortgage lenders will consider this a new business, even if you have a long trading history as a sole trader. You may need to seek specialist advice or face having your mortgage application delayed if you are not already on the property ladder.

So which should I choose?

As with all other aspects of running a business, there’s no clear-cut answer as to whether registering as a limited company is the right move for you. Instead, you must consider your business objectives and financial goals.

In either case, there is no getting around informing HMRC that you operate a business as a freelancer, including reporting your earnings and paying tax. It’s why becoming a sole trader is often the first port of call for freelancers, but that doesn’t mean you have to continue as a sole trader forever.

Read our guides and resources for more help and advice on becoming a self-employed freelancer.