Thinking about making the switch from a sole trader to a limited company? This guide will help you determine whether it’s the right step for your business and when to make the move.
Switching from sole trader to running a limited company involves some important business considerations. You will need to think about how your business will change and what new responsibilities you might face.
If you’re considering making the switch, here’s a straightforward guide of when to do it and what to watch out for with no jargon, just the essentials.
Why start my business as a sole trader?
Many people choose to start their small business or freelancing journey as a sole trader because it’s easy to set up and comes with minimal admin. However, as income grows, setting up a limited company often becomes a more attractive option.
If your earnings are relatively low, staying as a sole trader may be more practical. Tax compliance and accounting duties are simpler as a sole trader, which is a big advantage for those just starting out.
When should I switch to a limited company?
As your income increases, moving to a limited company can become a more cost-effective due to potential tax savings and enhancing your relationship with suppliers and customers, who may only trade with limited companies.
That said, recent tax changes such as the rise in Corporation Tax to 25%, the drop in Class 4 National Insurance from 9% to 6%, the higher Lower Profit Limit of £12,570, and Class 2 National Insurance becoming voluntary, means that sole traders now pay less tax than before.
However, limited companies still offer greater tax flexibility, especially with the way you manage your income. As a guideline, once your annual profits as a sole trader approach £50,000, you should consider forming a limited company.
What are the differences between Sole Trader and Limited company?
A separate legal entity
A limited company is a separate legal entity that is owned by one or more shareholders and managed by one or more directors. The same person can be a shareholder and a director, so you have the option to own and control the business by yourself (just like you do as a sole trader) or jointly with other people or partners you may have.
Separate bank account
While most sole traders use their personal bank accounts for business dealings, limited companies are required to have their own separate bank accounts as money in the business belongs to the company and not the directors.
Income and expenses are handled differently
Any income the business makes will be received in the company’s bank account. From a legal and tax perspective, owners cannot just withdraw money as they do when operating as a sole trader. Any income paid to the directors from the company needs to be in the form of salary or dividends. Dividends are distributed to owners from the final profits of the business after paying corporation tax.
Expenses for limited companies are more generous. Limited companies can claim full capital allowances on cars regardless of any private use which is a restriction for sole traders. Same applies for mobile phones and computers where companies are allowed full expense regardless of the private use by the owners.
Owners can charge rent for the use of their home for business purposes while this is not available to sole traders.
Different taxes to report
As a sole trader you are required to submit self-assessment to HMRC telling them the tax and National Insurance contributions you need to pay. As a director of a limited company, you still need to file a self-assessment with HMRC, only this time declaring any dividends taken from the company. If you take a salary the company will also need to fille regular monthly payroll with HMRC.
The limited company itself will need to file a yearly corporation tax return to HMRC and any other quarterly VAT returns if needed.
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How do I switch from a sole trader to limited company?
Incorporate with Companies House
Every limited company needs to be listed on the companies house public register. You will need to think of a name that currently does not exist on that register. As mentioned, every company needs to have at least one owner and one director. This can be the same person as long as that person has not been disqualified from being a director by companies house.
If you have a business partner of you would like your spouse or partner to be a director or shareholder, you will need to consider what legal rights and shares in the company to give them. These can be difficult decisions with potentially costly implications if you get them wrong, we recommend getting some professional advice from us.
Transfer assets from sole trader to limited company
If you have bought any assets when working as sole trader, you will be able to transfer them to the limited company on incorporation. When transferring the assets from sole trader to limited company, you may end up making capital gains on the transfer of those assets. However, HMRC has incorporation relief for sole traders that transfer all the assets (except cash) to limited companies in exchange of shares of that company. In practice, this is a more complicated matter, so it is vital you speak to an accountant for detailed advice.
Tell HMRC you made the switch to a limited company
When your company is set up and ready to trade, you must tell HMRC that have stopped being self-employed and you are not running as a sole trader anymore.
You will also need to file a final self-assessment as a sole trader reporting all income and expenses up to the date of which you stopped being self-employed. You must ensure that you file your final self-assessment tax return, and pay any tax that you owe, by the usual deadline of 31 January after the end of the tax year to which the return relates.
Do I need an accountant to help me setup my limited company?
You might have been used to working without any accounting systems for your business as a sole trader. However, running a limited company would require you to set up an accounting framework for your business for statutory and tax reporting purposes.
Accountants play key role in ensuring the limited company set up their accounts in a way that best suits their needs. Contact us today if you would like to discuss if you are thinking about switching from a sole trader to a limited company.
Spring Budget 2025 summary for small companies and sole traders
