It’s actually much easier to start a freelance business than you might think. You go out and get your first client, and boom – you’re in business.
You don’t have to be incorporated. You don’t have to have a business name or a website, and you don’t even have to register as self-employed straight away.
You can just start.
But, at some point, you do need to register with HMRC. And you will need to consider how you operate as a business and how to market yourself.
Limited Company Vs Sole Trader – what’s the difference?
I started freelancing as a sole trader and later switched to a limited company.
There are advantages and disadvantages to both, and what’s right for one person may not be right for another.
You’ll need to decide what’s best for your business. The good news is it is possible to switch if you need to (although this isn’t something you should do regularly).
What is a Sole Trader?
A sole trader is a single individual who runs their own business and works for themselves. That means they make all the decisions, have all the liability, cover all the costs and keep any profits. Being a sole trader doesn’t necessarily mean there is only one person in the business – a sole trader can hire employees.
What is a Limited Company?
A limited company can be formed by one or more people who will be the named directors. The company is its own legal entity, and the business finances and assets are separate from personal finances and assets. Limited companies are registered at Companies House.
Partnerships & LLPs
If you are starting a business with someone else, you may want to enter into a partnership or Limited Liability Partnership (LLP). I won’t be covering partnerships and LLPs here, but you can check out the government website to find out how it works.
Registering as a self-employed sole trader
Setting up a business as a sole trader involves less work than forming a limited company, which can be one advantage of choosing the sole trader route. To start trading as a sole trader, you simply need to register as self-employed with HMRC.
You do not have to do this immediately, but you must register if you have earned more than £1,000 in the previous tax year. You must register before 5th October in the business’s second tax year, or you could face a fine.
Once registered, you must complete a self-assessment tax return after every tax year. The UK tax year runs from 6th April to 5th April.
You can register here.
Setting up a limited company
Forming a limited company is not difficult, but it involves slightly more administration work and a very small cost (currently £12).
You need to register the company with Companies House. This is quite straightforward, and you can do it yourself. Alternatively, numerous third-party companies or accountants will help you do it for a small admin fee.
You will need to choose a business name, name the directors, and allocate shares. You will also need a registered address. If you don’t have an office address, you can use your home address. Alternatively, you can pay to use a registered address service.
Once your company is registered, you will receive a certificate of incorporation showing your unique company number and the date of incorporation.
You can register a limited company here.
Company names and trading names
You do not need a company name to start trading as a freelancer – you can trade under your own name for as long as you want.
As a sole trader, you can use your name as the company name, but you can also use a trading name if you want to.
You do not need to register your trading name, but your trading name is not protected. If somebody else decides to register a limited company using that name, they may do so.
If you are trading as a sole trader, you cannot use the words’ Ltd’ or ‘limited’ in your trading name. Your name must not be offensive, and there are some words you must avoid or get permission to use – for example, words that suggest a connection with government or local authorities.
Official documents, invoices and contracts should include your name. You can then add ‘t/a’ followed by your trading name – for example, John Smith t/a ABC Freelancers.
When choosing your company name, check Companies House to ensure your name isn’t too similar to another company in the same industry. If you use a name or logo that’s already in use or a registered trademark, the owner could take legal action against you.
If you are registering as a limited company, you register your business under your chosen name and can choose either Ltd or Limited to go at the end.
When you send official documents or letters, you should include your full company name – for example, ABC Freelancers Ltd. You do not have to include your name.
If you register as a limited company, no other business can register with the same name. However, they could register a similar company name. For example, there could be ABC Freelancers Ltd and ABC Freelancer Group Ltd.
Privacy
As a sole trader, you have more privacy than a limited company. When you register a company with Companies House, your name and registered address are available for anyone to view on the Companies House website.
You must also file your accounts with Companies House, and certain financial details are available for anybody to access if they so wish.
As a sole trader, you do not have to share your registration details or disclose financial information to the public.
Liability
One of the main advantages of registering as a limited company is that your business becomes a separate entity meaning you are not liable for company debt or legal action against the business. As a sole trader, you are personally liable if your business gets into debt or you are sued.
This means you may be forced to sell personal assets, such as your home, to pay off debts. If things go horribly wrong, you could end up having to file for bankruptcy.
As a limited company, your business is not linked to your personal accounts. If you get into debt, your company is liable. If you cannot pay, you may have to wind down your company, but your personal savings and assets are usually protected (unless you have been involved in fraudulent activities).
Some businesses are more at risk than others. For example, a copywriter working from home on a laptop will have less financial risk than a builder who will have to pay for vehicles, equipment and materials. A copywriter is also less likely to get sued. Poor copy will cause minimal cost or damage to a company, whereas a badly built property could put lives at risk.
Your industry may dictate whether you should go down the sole trader route or register as a limited company. In either case, you should ensure that you have adequate insurance. Most freelancers get professional indemnity insurance as a minimum.
Paying yourself
As a sole trader, you can pay yourself as and when you need to from the business. You must keep accurate records of business income and expenditure to complete your annual self-assessment. You will then pay income tax on your profits.
As a limited company, you can still take money from your business, but you report it slightly differently.
Most company directors take a combination of salary and dividends.
Your salary is deducted from the company profit, so it is not subject to corporation tax, but you will have to pay income tax and NI (if you exceed the personal allowance).
Dividends are not deducted from the company’s profit, so they are subject to corporation tax, but the income tax you pay on dividends is slightly lower than the income tax paid by sole traders. You can only take dividends if you make a profit.
If you need to borrow money from your business, it is also possible to do this. You must record all transactions to track what you have taken from your business and what you have borrowed.
Rates of corporation tax, dividend tax, and income tax go up and down, howway you pay yourself may need to change each year. That’s where it pays to have a good accountant.
Tax efficiency
As a sole trader, you pay income tax on all your profits. In the simplest terms, you record everything you have earned, deduct all your business expenses, and then pay tax and national insurance on whatever is left over (above the annual personal allowance).
Limited companies have to pay corporation tax on profits. Personal income is also subject to tax.
As a limited company, the most common structure is for a director to pay themselves a salary that equals less than the personal allowance. This salary is deducted from company profits and is not subject to corporation tax.
Company directors are also allowed to take some dividends from the business tax-free. For the tax year 2023-2024, this is set to be £1000, and for 2024-2025, it reduces to £500 (although this could change).
Any dividends taken after the tax-free allowance are subject to personal tax. All dividends are included in company profit, so they are subject to corporation tax too.
When the combined rate of corporation tax and tax on dividends works out at a lower rate than the rate of income tax sole traders have to pay, it can be more tax efficient to trade as a limited company. However, there is rarely any tax benefits to becoming a limited company if you do not earn more than the annual personal allowance from your business.
An accountant can help you determine whether tax savings can be made by forming a limited company.
Annual accounts
As a sole trader, you must submit a self-assessment to HMRC each tax year. This is relatively simple if you have accurate records of your income and expenditure.
You let HMRC know how much your business has been paid and how much you have spent. They will then calculate how much tax you need to pay.
As a limited company, you are required to file company tax returns with HMRC and Companies House each year. You will be fined if you do not submit the required information by the set deadlines. As well as your company tax returns, you also need to complete a self-assessment for your personal income.
It’s a good idea to get an accountant to take care of filing your returns on your behalf.
Bank accounts
You’re not legally required to set up a business bank account, but it makes managing your finances much easier and can help you build a credit history for your business.
You may also get additional features with a business account that aren’t available with a personal account.
It’s also worth noting that some banks specify in their terms and conditions that you cannot use your personal account for business transactions, so you might have to open a separate account.
As a limited company, your business is a separate legal entity, and the money belongs to the company, so it should be kept separately.
Credibility
Registering as a limited company can help with credibility.
Details about your company and finances are available on Companies House, and this transparency can make companies feel more at ease when doing business with you.
Some organisations won’t offer contracts to sole traders because of the liability risk. Some banks and lenders are also wary of lending to sole traders, so securing business loans or investments can be more difficult.
VAT registration
Regardless of whether you are a sole trader or a limited company, you must become VAT registered if you exceed the VAT taxable turnover. This is currently set at £85,000.
It is possible to register for VAT before you exceed the threshold, and many companies decide to become VAT registered even if they don’t have to. Sometimes this is to give the impression they are more profitable than they are, but usually, it is so they can reclaim VAT on business supplies.
If all your suppliers are VAT registered, it might make sense for you to become VAT registered too, so you can offset the VAT you pay. However, if all your clients are non-VAT registered, they won’t be able to offset the VAT, and the extra 20% you need to charge could impact sales.
An accountant can help you decide if this is the right route for your business.
Employing staff
You can employ staff regardless of whether you are a sole trader or a limited company.
Whatever type of company you are, you must meet all the legal requirements regarding tax, NIC and pensions. You will have to set up a PAYE scheme to ensure that you meet these requirements – many companies outsource this to an accountant or bookkeeper.
Summary: Sole Trader vs Limited Company
- Setting up as a sole trader is quicker and easier than forming a limited company
- Your trading name is not protected as a sole trader
- Your name, business address and some financial information will be publically accessible if you register as a limited company
- Sole traders are personally liable for any debt or legal actions against their business
- Limited companies may be more tax efficient
- Limited companies must file annual company accounts and pay corporation tax
- Limited companies can sometimes be perceived as more credible than sole traders