Sole trader or limited company: the best choice for freelances

One of the most common questions asked by the self-employed is whether to trade as a company or as an individual. The decision has implications for tax, legal and financial responsibilities, the amount of paperwork you will need to complete and how your peers view you. There is no straightforward answer, because different legal structures suit different situations.

ClearSky Accounting in Warrington works with both structures and often advises individuals about which path to take. Daniel Mepham, its business and development director, advises: "Once you have decided to be your own boss, you then need to choose the best structure for your business. This decision should be made at the outset, before you begin trading.

"The structure you choose can depend on your own personal situation and future plans, therefore the decision you make will have an impact on how you pay the relevant tax to HMRC."

The most appropriate structure will depend on a number of factors, including the tax implications, the legal entity, ownership and liability.

"Picking the wrong structure could see you paying more tax than is necessary," explains Mepham. "It is important to identify early on if the wrong structure is being used so a plan can be put in place to change to something more suitable."

Julie Stewart is chairman of PCG, the membership association for freelancers, contractors and independent professionals. She believes your choice could also affect how others view you.

"When you are choosing the best option for you, there are a number of things to consider," she says. "What sort of work will you be undertaking and equally importantly, what sort of clients will you be looking to engage with?"

Most freelancers choose to operate as a limited company simply because so many potential clients and agencies will only do business with individuals who operate in this way. The downsides of the limited company are more rules and regulations, accountancy fees tend to be higher and the penalties for getting your paperwork wrong are greater. Plus you will have to pay corporation tax and you can't just withdraw money from the business without formally recording it as a salary, dividend or loan.

However, Stewart says there are benefits to operating under a limited company. "First and foremost, it grants access to the many clients who will not engage with sole traders," she added. "There is also the fact that your personal assets are protected against company debts, so in situations where the client passes on the responsibility and risk from a project to you – which is an everyday part of life as a freelance – personal property, such as your house, has a level of protection."

When deciding which option is right for you – trading as a company or as an individual – look at the type of clients you will be pitching to for work. Stewart says: "If they require that you are a limited company in order to engage with you, it would be unwise not to comply.

"You also need to look at the environments you are likely to be working in and the risks involved. If your work includes highly sensitive IT security projects for global banking organisations, for example, protection from the risks involved if you or someone else makes a mistake is likely to be wise.

"For freelances looking for a simpler approach, working as a sole trader is a relatively uncomplicated choice that will allow you to focus fully on the important things – getting work and then delivering it to a high standard."

So how does each one work? Going freelance essentially means that you are setting yourself up as a business. To do this, you have to create a legal structure formally and let the authorities know how you are operating.

To operate as a sole trader, simply contact HMRC and register for self assessment. This can be done online and should be done by 5 October, following the end of the tax year that you are sending a return for. You will need to enter your earnings every year, and the tax will be calculated for you.

To form a limited company, it's a little more complicated. You will need to register with Companies House and receive a certificate of incorporation which confirms your company legally exists and shows the company number and date of formation. There are restrictions on company names, and who can act as a director and as company secretary. The Gov.uk website explains the process more fully.

Whichever path you choose, it's important to understand that your decision isn't final. It is always possible to change at a later date.

Louise Verity began her business as a hobby, selling hand-crafted wall art through Etsy.com and at craft fairs in 2009, going full time in 2011.

Verity says: "I started as a sole trader because my business was a hobby, and the income was very small. I grew very quickly and, once I hit the threshold where corporation tax might start to be more useful than just income tax, we decided that it would be worth registering the limited company. So we have the name should we need it.

"I'm not there yet, but it's good to know the name is mine in case."

She adds: "My business is still at the point where I don't have any risk – no loans or anything, so if I decided to stop, then there wouldn't really be any consequences. I grew slowly to begin with and then things took off. If I get much bigger, then I would consider separating the risk from my family using the limited company."

This piece was originally published in September 2013

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