The freelancer’s choice: sole trader or limited company?

Mary Whitehouse

Word Service | Copywriter for reports, websites and case studies

One of the biggest business questions freelancers face is what sort of organisation they should be: a sole trader or a limited company.

It’s a question I asked myself after a few years in business, and many other freelancers I know face the same conundrum.

What’s the best way to organise your company? Which is going to let you keep more of your money? And which is going to help you win more clients?

There are pros and cons of each option and, in truth, there’s no easy answer.

Here’s what I learned when I went through the process.

First things first: what’s the difference?

Even if it’s just you sitting in your spare bedroom on a keyboard, you’re running a

And, legally speaking, as a sole trader, you are your business.

In reality, this means that you can do whatever you like with the money you make, but you’re also personally liable for any of the debts of your business. There is no distinction between you and your company.

As a limited company, you are your employee. You’re also your boss. (Makes for startlingly effective salary negotiations, believe me.)

If you operate a limited company – even if you’re the only shareholder – your liability is limited (hence the name). Your business is a separate entity from you.

There are benefits and drawback to both arrangements. The main one freelancers tend to focus on is…

Tax. Less or more?

‘Pay less tax’ is an attractive proposition, isn’t it? However committed you are to the principles of fair taxation, reducing your personal burden is always going to make a freelancer’s ears prick up.

That’s nothing to feel bad about, though. Freelancers don’t get paid holidays, sick pay or an employer contributing to our pensions, so I, for one, don’t feel too bad about shaving a few quid off my contribution to the exchequer.

If your business is a limited company, you’re a shareholder and will take home a combination of salary and dividends.

The salary portion should be no more than the personal allowance (currently £12,500) and will be tax-free, although some National Insurance Contributions (NICs) will be payable if your salary is above £8,632).

You take your dividends from your profit after expenses and corporation tax. The first £2000 in dividends is tax-free, and any amount above that is currently taxed at 7.5% if you are a basic rate taxpayer (more if you are a higher or additional rate payer). You won’t pay national insurance on dividends, either.

A cost-effective way of reducing both the NICs payable on your salary and the tax payable on your dividends would be to pay yourself a salary of £9000 and use the rest of your personal allowance on dividends over £2000.

However, the Government has decided that the amount you get for free will reduce year on year, so it’s important to keep an eye on this.

Your business will also pay corporation tax – a tax on your profits – which currently stands at 19%, and is planned to reduce to 17% in 2020.

If you are a sole trader, you will pay income tax on your profits in the same way you do as an employee – currently 20% on everything above £12,500, 40% on anything from £50,001 to £150,000, and 45% on anything above £150,000.

You won’t pay corporation tax, but you still have to pay everything else, including VAT, capital gains tax and so on.

Looks like a no-brainer!

Not so fast! In many cases, incorporation is a good financial move. But beware of the following:

  • If your taxable profits are less than £25,000 or thereabouts, the additional admin and likely accountancy costs involved in being a limited company will probably outweigh the tax gains.
  • It’s quite easy to do your own accounts as a sole trader. But please employ an accountant when you go limited. You’ll need to send annual accounts and your company tax return to HMRC and Companies House, and set up a payroll to pay your salary. This is quite tricky and time-consuming for a freelancer (unless you’re a freelance accountant, of course. In which case, go for it).
  • If you already have an accountant, you’re halfway there. But be prepared for their costs to go up to cover the extra work they’ll be doing.
  • Remember, the money that the company earns is not yours. You take your income as a salary or a dividend from the post-tax profits. Therefore, the bank balance of the company does not represent the amount you can draw. Drawing too much from the company can lead to a nasty tax bill at the end of the year!

Don’t forget your pension

If you’re anything like me and have been freelance and financially innocent for ages, your pension might just buy you a few extra logs for your meagre fire after retirement.

It’s quite scary the amount we should be saving for a comfortable retirement. And if you’re not on the payroll of a company with a decent pension scheme, it’s up to you to make it happen.

Whatever your self-employment status, you’ll get tax relief on your pension contributions. But as a director, making contributions direct from your limited company can be much more financially effective.

Your company can pay into your personal pension pot and receive corporation tax relief on the amounts that it pays. It’s an excellent tax-free way of getting money out of your company for your own personal benefit.

It’s about more than money

Most freelancers incorporate mainly for financial reasons, but there’s more to it than money.

Look the biz

Many organisations prefer to work with limited companies (often for tax reasons). I’ve personally worked with companies that won’t deal with sole traders at all.

As a limited company, you can appear more professional and business-like to potential clients. And you get to call yourself a director, which sounds great. They don’t know you do business on a laptop in your PJs.

Protect yourself

For me, this is one of the biggest advantages of incorporation. Because you’re a separate legal entity from your business, you and your home and personal assets are protected if the worst happens and your business goes bust owing money to suppliers.

You may think you’ll never get to that stage, but if you’re owed a lot of money by a big business with a dodgy payment record, which then goes under, the knock-on effect could be significant. Remember Carillion and their 120-day payment terms?

What’s not to like?

There are some drawbacks to incorporation, obviously. The increased admin for one thing – although employing an accountant, if you can afford to, means you’ll see very little difference in your day-to-day tasks.

If you like to keep your business finances private, it’s harder to do as a limited company. As a director, you’ll be searchable on the database of Companies House, along with any other companies you’ve been involved with.

Your accounts will also be available at Companies House for anybody wishing to take a look (although only an abbreviated version is filed, so items such as turnover, profits and dividends drawn are not on show).

You’ll also need to be aware of the IR35 legislation if you work predominantly in the public sector, or only for one client. IR35 applies if you would ordinarily be ‘employed’, without the protection of a limited company. (Some BBC presenters have been caught out by this.)

The answer? There isn’t one

If this blog teaches you anything, it’s that there’s no easy answer to the limited company or sole trader question. It all depends on your individual circumstances.

It could be that you’re better starting out as a sole trader to keep costs down. Then you can incorporate once you’re a few years down the line and have profits to make it worthwhile.

Incorporating your business costs very little and is a simple online application. Dissolving a company, or removing it from the register, is a whole other story.

Many thanks to my accountant, Robert Chance of Neal & Co for his help with the financial, tax and legal aspects of this blog.

This post first appeared on

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