A sole trader should consider becoming a limited company when specific financial, legal, and strategic factors suggest it’s the best option for business growth. There is no answer that fits all as everyone’s situation is different Here are key considerations that might indicate when it’s time to make the switch:
1. Tax Efficiency
One of the main reasons sole traders convert to a limited company is the potential for tax savings.
- As a sole trader, you are taxed on all your profits at income tax rates (20%, 40%, or 45%), which can result in higher tax bills as your profits grow.
- Limited companies pay corporation tax on profits, which is currently 19% for your first £50,000 profits, 25% for above this with marginal relief between £50,000 and £250,000 (2024/25). As a company director, you can also take a salary and receive dividends from the profits. Dividends are taxed at lower rates than income, potentially lowering your overall tax burden.
When to consider: If your business profits are above £50,000, incorporating may reduce your tax liability, making the limited company structure more tax-efficient.
2. Limiting Personal Liability
As a sole trader, there’s no distinction between your personal and business assets. This means you’re personally liable for all business debts and legal claims, putting your personal finances (e.g home, savings) at risk.
In contrast, a limited company is a separate legal entity. This provides limited liability protection, your personal assets are protected, and you’re only liable up to the amount you invest in the business (e.g your shares in the company).
When to consider: If your business is growing, taking on more financial commitments, or facing increased legal or operational risks, becoming a limited company can protect your personal assets.
3. Raising Finance
Limited companies often find it easier to attract investment and finance. Investors typically prefer limited companies because they can issue shares and offer equity in exchange for investment. Banks and lenders may also be more willing to provide loans to limited companies.
When to consider: If you need to raise substantial capital for growth, or are considering bringing in investors or partners, a limited company structure is often the better choice.
4. Business Reputation and Credibility
Operating as a limited company can enhance your business’s reputation, particularly with larger clients and corporate customers. Many companies prefer working with other incorporated businesses because it reflects professionalism and financial stability.
When to consider: If you’re working with bigger clients, especially in industries like construction, finance, or consulting, being a limited company can help improve your credibility and open doors to larger contracts.
5. Profit Retention and Long-Term Planning
In a limited company, you have more flexibility in how you distribute profits. You can:
- Pay yourself a salary.
- Pay dividends (which may be more tax-efficient) to yourself and other individuals
- Retain profits within the company for reinvestment or future growth.
As a sole trader, all profits are subject to income tax in the year they are earned, whereas limited companies can retain profits to be taxed later when it is more tax-efficient.
When to consider: If you’re planning to reinvest profits in the business, or you want to retain profits for future use, a limited company structure offers greater flexibility.
6. Expanding or Hiring Employees
While sole traders can hire employees, a limited company structure may make payroll, employment taxes, and employee benefits easier to manage. You can also pay yourself as an employee of the company and take advantage of tax reliefs on pension contributions and other benefits.
When to consider: If your business is expanding and you’re hiring more employees, managing payroll and tax-efficient compensation is often more streamlined in a limited company.
7. Paying Yourself Flexibly
As a sole trader, your income is the business’s profits, and you pay income tax and National Insurance on the entire amount. In a limited company, you can take a small salary up to the personal allowance (currently £12,570) and take the rest of your income in dividends, which may reduce your tax bill.
When to consider: If you want more control over how you pay yourself to optimize taxes and benefits, incorporating can give you that flexibility.
8. Growth Beyond a Lifestyle Business
If your business is growing beyond a simple lifestyle business (one that’s designed mainly to support your personal income needs), becoming a limited company can support larger operations, allow for partnerships, and create a more scalable structure.
When to consider: If your business is becoming more than just a source of personal income, and you’re aiming for significant growth, restructuring as a limited company may offer the scalability you need.
9. Retirement and Succession Planning
A limited company provides more flexibility for succession planning. It’s easier to sell shares, transfer ownership, or bring on partners without disrupting the company. Additionally, limited companies can continue operating after the owner’s death or retirement.
When to consider: If you’re thinking about exit strategies or long-term planning, a limited company allows for smoother transitions and opportunities to sell the business in the future.
10. Access to More Tax Reliefs and Incentives
Limited companies may qualify for tax reliefs that aren’t available to sole traders, such as:
- Research and Development (R&D) tax credits
- Capital Gains Tax relief on certain investments
- Entrepreneurs’ Relief (now called Business Asset Disposal Relief)
- Lower tax rates on profits compared to higher personal tax rates.
When to consider: If your business qualifies for any of these reliefs, incorporating as a limited company can unlock valuable tax savings.
Conclusion Sole traders should consider becoming a limited company when their business has grown to a point where tax efficiency, personal liability protection, raising capital, and business credibility become important factors. Consulting with an accountant or financial advisor can help you assess whether it’s the right time to make the switch based on your specific circumstances and goals.
If you need any assistance with transitioning from a sole trader into a limited company, or would just like to speak to an expert to find out your options, please feel free to get in touch and our accounting specialist Elliott for a free, no-obligation initial consultation.
