Note: I first created this blog in 2019 and it’s one of the most-read articles on my website. Since then, governments, rules and rates have changed, so I’ve updated it to include advice and figures that are correct at the time of posting – in the 2025-26 tax year. If you’re reading it later than then, please check the gov.uk website for the latest rates. Also note that this just refers to UK taxes and legislation, and that I’m not a tax specialist, so please seek professional advice before making any decisions this article may influence.
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 with each option and, in truth, there’s no easy answer. But here’s what I learned when I went through the process.
Even if it’s just you sitting in your spare bedroom on a keyboard, you’re running a business.
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.
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 drawbacks to both arrangements. The main one freelancers tend to focus on is…
‘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 pick up.
That’s nothing to feel bad about, though. Freelancers don’t get paid holidays or sick pay, or have 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 are a shareholder and will take home a combination of salary and dividends.
For maximum tax-efficiency, the salary portion of your income should be no more than the personal allowance (currently £12,570) and will be tax-free. Employee national insurance contributions (NICs) are also payable above this level.
As you are also your employer, you’ll have to pay employer NICs on your salary above £5000. However, even taking this into account, paying yourself a £12,570 director salary remains the most tax-efficient way to extract income up to the personal allowance, because salary is fully deductible for corporation tax and avoids dividend tax.
(This changes if and when the company has more than one employee – but we’re just looking at solo directors for the purposes of this blog.)
You take your dividends from your profit after expenses and corporation tax. When I originally wrote this blog in 2019, the first £2000 in dividends was tax-free – now it’s only the first £500. Any amount above that £500 allowance is currently taxed at 8.75% if you are a basic rate taxpayer, 33.75% if you are a higher rate payer, and 39.95% if you’re an additional rate payer.
The dividend allowance has been reducing year on year since 2018 when the chancellor at the time, Philip Hammond, committed to reducing the ‘unfairness’ of taking income via dividends rather than via a salary.
The current chancellor, Rachel Reeves, has promised no further reduction in the 2026-27 tax year, but the direction of travel is clear, and most expect all dividends to be taxable within a few years – albeit at a lower rate than salaried income.
In short, it’s not as tax-efficient as it used to be.
That’s not all, though. On top of your personal tax, your business will also pay corporation tax on your profits. The rates currently stand at 19% for profits under £50,000, gradually increasing to 25% for profits over £250,000.
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 £12,570, 40% on anything from £50,271 to £125,140 and 45% on anything above that.
You’ll also pay Class 4 NICs at 6% on profits between £12,570 and £50,270, and Class 4 NICs at 2% above £50,270.
You won’t pay corporation tax, but you still have to pay everything else, including VAT, capital gains tax and so on.
Not so fast! In many cases, incorporation is often a good financial move. But remember the following:
If your taxable profits are less than £25,000 or thereabouts, the additional compliance, admin and likely accountancy costs involved in being a limited company will probably outweigh the tax advantages.
At lower profit levels, and where most income is taken out each year, sole trader status often remains more efficient.
However, if you leave money in the business for reinvestment, future income or retirement planning, it will be taxed at corporation tax rates, which are generally lower than personal tax rates
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)
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!
Quite a few people think that, as a limited company, they need to register for VAT – an additional tax you add to all your invoices and claim back from some of your expenses.
However, VAT has nothing to do with your company status. It applies to any business, whether a sole trader or limited company – once its turnover exceeds £90,000. Check the gov.uk website to see if and how it may apply to yours.
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 directly 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.
Most freelancers incorporate mainly for financial reasons, but there’s more to it than money.
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 businesslike 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.
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. Many huge companies still apply these ridiculous terms on their suppliers even now.
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.)
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 Martin Brooks from Gold Stag Accounts for his invaluable help updating the financial and tax aspects of this blog.
