Sole trader or limited company: What’s best for freelancers?

Sole trader is the simplest structure, which explains why almost 60% of our customer base operate as one.

What makes it straightforward compared to operating as a limited company?

1. Registering as a sole trader is quick
2. Business expenses can be offset against your trading income
3. Income tax is paid annually through the self-assessment system
4. You can use a personal account for your business instead of setting up a separate bank account to handle your earnings

However, it isn’t considered a separate legal entity and that’s something to be mindful of. You are your business.

This makes it riskier because you’re personally liable for debts and legal obligations. There’s no distinction between your business and personal assets.

When I was a freelance photographer I registered as a sole trader because there was less paperwork. To reduce my personal risk I protected myself with insurance. This meant that if a client recovered damages from me in respect of my photography services, the insurer would cover those fees so that I wouldn’t have to sell my car or spiral into debt!

Thankfully that never happened, but insurance can mitigate some of the risk when operating as a sole trader.

When to consider registering as a limited company

Almost 60% of our customers have registered as sole traders. Those who have opted to function as a limited company did so because:

1. They wanted the business to be a legal entity of its own
2. It can be more tax efficient due to corporation tax being lower than the income tax rate
3. You can split your income between salary and dividends
4. They wanted to protect their personal assets because they own a home

Despite the tax requirements being more complex, there are an abundance of tools to organise your admin like Xero and FreeAgent. Yes, there’s more paperwork involved with limited companies but it shouldn’t be a hassle if you keep on top of your accounts.

Factors that may impact your choice

Choosing whether to operate as a sole trader or a limited company is a business decision that only you can make. Most freelancers decide based on a combination of factors like:

• profits (being a sole trader becomes less tax efficient once profits grow)
• appetite to risk (as a sole trader you are your business)
• professional services (if you’ve developed a SaaS app you may wish to raise funding. Being a limited company makes this easier)
• professionalism (some clients may prefer working with limited companies)
• IR35 (being a sole trader means you’re not impacted by IR35 since it relates only to disguised employment through limited companies)

If you have an accountant you should speak to them. They’ll be able to advise on structuring your business based on your circumstances.

Tom from The3Key, an accountancy practice that specialises in creative and design freelancers, provides his take on the pros and cons from an accountant’s perspective.

“You will discover there are Pros and Cons to both sides when determining whether you should be a sole trader or limited company. With that in mind, it is crucial you make an educated decision. Switching between the two is possible, but it will result in some administrative tasks, meaning that if you can make the correct decision from the get-go, it is wise to do so.

In my opinion, there are three major aspects to this decision. One of these is risk because, as With Jack correctly points out, being a sole trader does potentially put your personal assets on the line. I won’t repeat this because it’s been excellently explained already.

Being a limited company means you have more tax and accountancy matters to deal with than if you were to operate as a sole trader. An accountant will be able to hold your hand throughout these, but this does result in additional fees. Once your profits (not turnover) are above £55k, it usually makes sense to be a limited company. This is the point where the additional accountancy fees are covered, and you’re left with extra money in your pocket!

Lastly, IR35 is the potential curveball, which overrides everything I’ve explained in the previous paragraph. Some recruiters and agencies refuse to work with sole traders directly and push them towards an umbrella company. Essentially, you become an employee of this business. To achieve a similar take-home as an employee of an umbrella company as you would working directly with the client, you need to increase your day rate by approximately 30-40%, which is often unlikely. However, these same recruiters and agencies are often much more flexible when working with limited companies and do allow you to work directly with them. This isn’t always the case, so please do double-check. Due to this, the £55k profit figure becomes irrelevant because you are capable of achieving higher revenue levels as a limited company. It only takes a few jobs directly with your limited company, as opposed to via an umbrella company, to reap the financial rewards.”

Switching to a limited company

Don’t worry if you decide to change the structure of your business down the line. As Tom said above, there are some administrative tasks when switching to a limited company so ideally you’ll make the correct call from day one. However, don’t let fear of choosing the wrong structure paralyse you from actually starting a business.

The advice from experienced freelancers is to start simple. Get some clients and worry about the best set up later. We regularly help freelancers switch their sole trader policy over to a Limited company one so it seems many make the transition once it makes financial sense.

Does the structure of your freelance business impact your insurance?

We get a lot of questions about whether we can arrange insurance for limited companies. We also have a lot of existing customers ask how their insurance will be impacted once they become a limited company.

The short answer is; this isn’t a problem.

Your insurance policy is designed to defend valid claims brought against the named entity. The legal structure doesn’t impact this. If you’re currently insured as a sole trader then it’s a simple case of updating the policy to your limited company name.

In a nutshell you should speak to an accountant, consider revenue, personal assets and the type of clients you want to work with. This will help you decide whether to register as a sole trader or limited company, but don’t get hung up on whatever decision you land on. You’re not tied to it forever!