Should I be a sole trader or a limited company? Tax explained

With freelancers and the self-employed, just like with other workers, money talks!

But take-home pay can be more complicated to work out when you work for yourself, and it depends on the business structure you opt for – sole trader or limited company, writes chartered accountant Graham Jenner, founder of tax advisory Jenner & Co.

Tax & National Insurance: Sole Trader vs Ltd Company

Below is a table based on the rates of the current year tax (2022-23), showing the overall tax payable, at different profit levels, for each of the above freelance working structures -- sole trader and limited company.

The approximate savings from operating as a limited company, rather than as a sole trader, are also presented.

Annual Profit (£)

Sole trader

(Tax and NI due to HMRC; £)

Limited Company

(Total tax and NI due from company and individual: £)

Saving as a Ltd (£)

20,000

2,300

1,900

400

30,000

5,300

4,400

900

40,000

8,400

6,900

1,500

50,000

11,400

9,400

2,000

60,000

16,400

11,900

4,500

70,000

20,800

16,100

4,700

80,000

25,200

20,600

4,600

90,000

29,500

25,200

4,300

100,000

33,800

29,700

4,100

110,000

38,100

34,200

3,900

120,000

42,500

38,800

3,700

130,000

46,800

43,300

3,500

140,000

51,100

47,800

3,300

150,000

55,400

52,300

3,100

160,000

60,300

56,900

3,400

170,000

65,100

61,400

3,700

As the table shows, there are significant potential savings in tax and national insurance by providing freelance services through a limited company rather than as a sole trader.

In addition, the limited company (as a structure) provides potential for additional savings.

Broadly, these are two-fold.

Smoothing out income fluctuations to minimise tax? You must be 'LTD'

Firstly, if taking all of the available profit as dividends would take you into higher rate tax, you could choose to take less in a tax year. If a later year is not as profitable, the retained profits of the first year could then be paid as dividends without going into higher rates of tax. Effectively, with a company, there is the potential to smooth out fluctuations in income to minimise the tax. With a sole trader, there is no such potential – if the profit is made and takes the individual into higher rate tax, then that is what has to be paid to HMRC.

Secondly, with a limited company, it may be possible to include your spouse or partner as a director (and pay them a salary) or as a shareholder (and pay them some dividends). The effect of either is to reduce the overall tax due to HMRC.

Beware IR35 if you become a limited company

But what if IR35 applies? This is a very important question to consider if you do go down the limited company route.

Although the table above shows that a limited company would provide a tax saving compared to a sole trader, the table assumes that IR35 does not apply to the company’s freelance contracts.

If IR35 does apply, then the limited company goes from being the best option to the worst!

Know the value in IR35 contract negotiation

Your first step when a limited company should therefore be to try to negotiate a contract with terms that keep it outside IR35. All too often, we see a standard contract assessed as being inside IR35, when a slightly different contract could be negotiated to be outside IR35, and still be totally acceptable to both the client and the freelancer!

If an outside IR35 determination is not possible, but the client still wants you to be a freelancer, then they will be issuing you with a sole trader (or self-employed) contract.

Yet here is the odd thing – if the client is prepared to issue a contract on a self-employed basis (to you as a sole trader), then a similar contract issued to your limited company would be outside IR35!

Other financial factors to factor-in before you form a company

While the table above correctly shows potential tax saving, be ready for additional costs if you form a limited company.

In fact, operating through a limited company is slightly more expensive than operating as a sole trader, in terms of accountancy costs and meeting statutory filing obligations.

Lastly, if limited, prep for more administration and responsibility

Finally, even though money matters, it’s not just a financial decision when it comes to choosing between being a limited company or a sole trader!

With a limited company comes the added responsibilities of being a director, and additional administrative matters to deal with which sole traders needn’t concern themselves with.

But look into these and check them against your appetite for activity, responsibility and administration. In practice, and in our experience, neither of these tend to be too onerous for freelancers!