Sole Trader vs Limited Company: The Legal Differences and Which to Choose
A sole trader is personally liable for business debts and taxed through Self Assessment; a limited company is a separate legal person that pays corporation tax, files public accounts and shields its owners from most debts.
Key points
- A sole trader is personally liable for all business debts; a limited company is a separate legal person and shareholders normally risk only what they paid for their shares.
- Sole traders pay income tax and Class 4 National Insurance on profits; companies pay corporation tax at 19 to 25 per cent, and owners pay dividend tax on what they take out.
- Registering as a sole trader is free, by 5 October after your first tax year; incorporating online costs £100 and a company files a £50 confirmation statement and accounts every year.
- Company directors must verify their identity with Companies House, mandatory since 18 November 2025, and owe statutory duties under the Companies Act 2006.
- The £90,000 VAT threshold and employment law apply to both structures; the choice turns on liability, credibility, privacy and how much profit you reinvest.
A sole trader is a person in business on their own account: there is no legal line between you and the business, so you keep all the profit after tax but you are personally liable for every debt. A limited company is a separate legal person registered at Companies House: it owns the assets, signs the contracts and owes the debts, and your liability as a shareholder is normally limited to what you paid for your shares. That difference drives everything else, from how you are taxed to how much paperwork you file and what the public can see about you. This guide compares the two structures as they stand in the 2026/27 tax year, covers registration, running costs, directors' duties, staff and switching, and explains where a solicitor and an accountant each earn their fee. Company law and most business taxes are the same across the UK, with the one significant difference, Scottish income tax, noted below.
Liability: the central difference
As a sole trader you contract in your own name, so if a customer sues, a supplier goes unpaid or HMRC assesses a tax bill, your savings, your car and ultimately your home are available to meet it. Insurance covers some risks, notably public liability and professional indemnity, but not trading losses or a contract you cannot honour. Partnerships work the same way, with each partner liable for the firm's debts.
A limited company's debts belong to the company. If it fails, creditors can take the company's assets but not yours, unless you have given a personal guarantee, which banks, landlords and many suppliers ask small company owners to sign and which removes the protection for that debt. Directors can also be made personally liable for wrongful trading under section 214 of the Insolvency Act 1986 if they carry on trading when they knew, or should have known, that insolvency was unavoidable, and a director who runs a company badly can be disqualified from acting as one for up to fifteen years. Limited liability is real, but it is not a licence to take risks with other people's money.
How each is taxed in 2026/27
Sole traders
Your trading profit is added to your other income and taxed through Self Assessment. For 2026/27 the personal allowance is £12,570, the basic rate of 20 per cent applies to taxable income up to £50,270, the higher rate of 40 per cent up to £125,140 and the additional rate of 45 per cent above that; the allowance tapers away once income passes £100,000, and the thresholds are frozen until April 2031. Scottish taxpayers pay different income tax rates and bands on trading profits. On top of income tax you pay Class 4 National Insurance at 6 per cent on profits between £12,570 and £50,270 and 2 per cent above that. Class 2 contributions are no longer compulsory: if your profits reach £7,105 you are treated as having paid them and keep your state pension record, and below that you can pay voluntarily at £3.65 a week.
Tax is paid in two instalments on 31 January and 31 July, with payments on account for the following year once your bill exceeds £1,000. Since 6 April 2026 sole traders and landlords with qualifying income over £50,000 must keep digital records and send quarterly updates to HMRC under Making Tax Digital for Income Tax; the threshold falls to £30,000 from April 2027 and £20,000 from April 2028.
Limited companies
The company pays corporation tax on its profits: 19 per cent where profits are £50,000 or less, 25 per cent where they exceed £250,000, and a tapered rate between the two through marginal relief. The limits are shared between companies under common control. The return is due twelve months after the year end but the tax is payable nine months and one day after it.
You then decide how to take money out. Most owner-managers pay themselves a modest salary, which is deductible for the company, and take the rest as dividends from profits that have already borne corporation tax. Dividends above the £500 allowance are taxed at 10.75 per cent for basic rate taxpayers, 35.75 per cent for higher rate and 39.35 per cent for additional rate, the two lower rates having risen by two percentage points on 6 April 2026. Employer National Insurance is 15 per cent on salary above £5,000 a year; the £10,500 Employment Allowance offsets it but is not available to a company whose only employee paid above the threshold is its director. The overall tax saving from incorporation is now smaller than it was a decade ago and depends heavily on how much profit you leave in the company, so take an accountant's projection before choosing on tax grounds alone.
Both structures must register for VAT once taxable turnover in any rolling twelve months exceeds £90,000, and both can register voluntarily below that.
Registration, filing and public records
Setting up as a sole trader costs nothing. You register for Self Assessment with HMRC by 5 October after the end of the tax year in which you started, so someone who begins trading in June 2026 must register by 5 October 2027, and you file one tax return a year. You can trade under a business name provided you do not use words such as limited or Ltd and your own name appears on business letters, invoices and your website. Nothing about your accounts is public.
Incorporating a company online at Companies House has cost £100 since 1 February 2026 (it was £50 before that), and a formation agent or solicitor adds its own fee. Each year the company files a confirmation statement, now £50 online, and annual accounts within nine months of its financial year end, plus a corporation tax return to HMRC. Small companies can still file abridged accounts, or filleted accounts that leave out the profit and loss account; a plan to make them file it was paused in January 2026, and from April 2028 accounts must be filed through software. The register is public: anyone can see the directors, the people with significant control, the registered office and the filed accounts, which is why many sole traders stay as they are until the business grows.
Since 18 November 2025 every new director and person with significant control has had to verify their identity with Companies House under the Economic Crime and Corporate Transparency Act 2023. Existing directors must verify when their company files its first confirmation statement after that date, so the transition ends in November 2026, and a confirmation statement cannot be filed until all directors have done so. Verification is free through GOV.UK One Login, or an accountant, solicitor or other authorised agent can do it for a fee. The company must also display its registered name, number and office on letters, emails and its website.
Directors' duties and running the company
Becoming a director brings statutory duties under sections 171 to 177 of the Companies Act 2006: to act within your powers, to promote the success of the company for the benefit of its members, to exercise independent judgment and reasonable care, skill and diligence, to avoid conflicts of interest, not to accept benefits from third parties and to declare any interest in a proposed transaction. The money in the company bank account is the company's, not yours: drawings beyond salary and declared dividends become a director's loan that must be repaid or taxed, and dividends can only be paid out of distributable profits.
Where there is more than one shareholder, the articles of association and a separate shareholders' agreement should settle who decides what, how shares are valued and transferred if someone leaves, and what happens in a deadlock. The guide to corporate law explains the framework in more depth. Sole traders have no equivalent formalities, which is their great advantage: there is no board, no register and no minutes, only the obligation to keep records for HMRC.
Credibility, contracts and taking on staff
Some customers, particularly larger businesses and public bodies, prefer or insist on dealing with a limited company, and agencies in some sectors will only contract with one. A company can also grant a floating charge, bring in investors by issuing shares and survive a change of owner, none of which a sole trader can do. Against that, a new company with no filed accounts has little credit history, so suppliers may ask for payment up front or a personal guarantee.
Contracts should be in the right name. A sole trader signs personally; a company signs through a director, and a contract made in the wrong name can leave you personally liable or unable to enforce it. If you take on staff, both structures must register as an employer with HMRC, operate PAYE, enrol eligible workers in a workplace pension and hold employers' liability insurance of at least £5 million, with a fine of up to £2,500 for each day without it. Employment law treats a sole trader employer exactly like a company. The guide on employment contract costs covers getting the paperwork drafted, and if a customer fails to pay, the process for recovering a debt through the small claims court is the same for both.
Switching later
Many businesses start as a sole trader and incorporate once profits, risk or customer demands justify it. Incorporating means forming the company, transferring the business and its assets to it (usually in exchange for shares, so that incorporation relief defers any capital gains tax), novating contracts and leases into the company's name, telling HMRC and transferring any VAT registration, and opening new bank accounts. Going the other way, from company to sole trader, means extracting the assets, settling the company's tax and striking it off, which costs £13 online if the company is solvent and has stopped trading, or a formal liquidation if it is not. Both moves have tax consequences that are easy to get wrong, so plan them with an accountant and a solicitor together rather than filing the forms yourself.
When to use a solicitor and an accountant
An accountant handles the numbers: the choice of structure on tax grounds, registrations, bookkeeping, payroll, VAT and the annual filings. A business law solicitor deals with the legal relationships: bespoke articles and a shareholders' agreement where there is more than one owner, terms and conditions of business, supplier and customer contracts, protecting the business name as a trade mark, a commercial lease if you take premises, employment contracts, and any dispute. Forming a plain company with model articles is something you can do yourself on GOV.UK for the £100 fee; it is the documents around it that need drafting.
Expect fixed fees for standard documents and hourly rates for negotiation and advice, and ask what is included before you instruct. Compare business law solicitors in Bristol or search business solicitors in London, and read the introduction to business law for the areas you are likely to meet in the first year.
Frequently asked questions
Is it cheaper to run a limited company than to be a sole trader?
Not necessarily. A company has running costs a sole trader avoids: the £100 incorporation fee, a £50 confirmation statement each year, statutory accounts and a corporation tax return, which usually means higher accountancy fees. Tax savings come mainly from leaving profit in the company at 19 or 25 per cent rather than drawing it all, and the dividend tax rises in April 2026 have narrowed the gap. Ask an accountant to model both structures on your expected profits.
Can I be a sole trader and a company director at the same time?
Yes. Many people run a sole trader business alongside a directorship, or keep one trade as a sole trader while another is in a company. Each is taxed separately: the sole trader profits go on your Self Assessment return with your salary and dividends from the company, and the company files its own accounts and corporation tax return. Keep the finances, contracts and invoices of the two clearly apart, because mixing them undermines the company's separate identity.
Do I need a solicitor to set up a limited company?
No. You can incorporate directly with Companies House online for £100 using the standard model articles, and many people do. A solicitor becomes worthwhile when there is more than one shareholder, when investors are involved, when you are transferring an existing business into the company, or when you need customer terms, supplier contracts, a lease or employment contracts drafted. Those documents, not the formation itself, are where legal advice saves money later.
What happens to the debts if my limited company fails?
The company's creditors are paid from the company's assets, and once those are exhausted the debts die with the company. You lose what you put in, but your personal assets are safe unless you gave a personal guarantee, which is common for bank borrowing and leases, or you continued trading when you knew the company could not avoid insolvency, which can make you personally liable for wrongful trading and lead to disqualification as a director.
When do I have to register for VAT?
When your taxable turnover in any rolling twelve-month period goes over £90,000, or when you expect it to exceed that figure in the next 30 days. The rule is the same for sole traders and companies, and the clock is measured by turnover, not profit. You can register voluntarily below the threshold, which lets you reclaim VAT on costs and can suit a business selling mainly to other VAT-registered firms.
Can I switch from sole trader to a limited company later?
Yes, and it is a common route. You form the company, transfer the business to it (normally in return for shares so that incorporation relief defers capital gains tax), move contracts, leases, insurance and any VAT registration into the company's name, tell HMRC the sole trader business has ceased and open company bank accounts. Timing the change at the start of a tax year keeps the paperwork simpler, and an accountant and a solicitor should work on it together.
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This guide describes the law in United Kingdom as at 30 October 2026. It is general information, not legal advice about your situation; the law and the figures it quotes change, so check the position with a solicitor before acting. LawFirms.co.uk is a directory and does not provide legal services.