Setting up as your own boss sounds like the perfect way to work. The freedom it offers attracts many people, but it can be difficult to work out whether self-employment or a limited company is the best option.

Both structures have their respective advantages, but a limited company takes longer to set up.

Self employed: Setting up as a sole trader

The simplest way to set up as self employed is by becoming a sole trader. Registering as a sole trader essentially means that you are in complete control of your business. You make all the decisions, you retain all the profits (rather than paying dividends to shareholders), and you are responsible for keeping records and accounts.

You are also liable personally for business debts – so think carefully before becoming a sole trader if your business is likely to run up substantial debt at times. If you get into trouble, you could lose all your assets including your home.

Sole traders must file a tax return each year, and pay fixed-rate Class 2 National Insurance contributions. The profits you make are taxed as income. Class 4 National Insurance is also paid on any profits made.

Setting up as a sole trader is easy – and free of charge. First you must register as self employed, for tax self-assessment, with HM Revenue & Customs. If you expect to employ staff or have a turnover above £73,000 per year, you may also need to register for Pay As You Earn (PAYE) or Value Added Tax (VAT) respectively.

You will also have to register to pay National Insurance, again with HMRC.

Limited Company

The main advantage of setting up a limited company (ltd) is to keep your business affairs separate from your personal finances. The directors of a private limited company that gets into trouble will only risk losing the money they have invested.

However, they are more difficult to set up. Limited companies must be incorporated at Companies House, a process which involves registering a company name, submitting a Memorandum and Articles of Association, and details of the structure of the business. They will also have to register for PAYE as employers and VAT, if turnover is above £73,000 per year

The cost of this varies – it can be done for less than £50 using online systems, but many specialist companies and accountants offer complete set-up packages at a range of prices.

A limited company must have at least one director and at least one member, and may also appoint a company secretary.

Annual accounts and a company tax return must be submitted each year, and all limited companies pay corporation tax. The structure of a limited company is often an advantage for tax purposes, as directors often pay themselves a small salary and take the bulk of their pay in the form of dividends on the shares they own, once a profit is made.

Limited companies also have the benefit of enabling directors to know exactly how much of the company they own, in the form of shares.

Which is best?

For one-person operations offering services such as virtual assistance, becoming a sole trader is the most straightforward way to get started. If the business grows, limited company status can always be adopted later on.

But the relative advantages and disadvantages apply differently to each business. If in doubt, it may be best to seek a professional opinion from a business advisor or accountant.

Useful resources

Business Link – A government-supported business advice website with comprehensive information on how to set up and run all sorts of companies. It’s also free.

How to register a limited company for under £30 – A quick guide on how to register a company without paying expensive accountancy fees.

Companies House Online Incorporation – A quick way to register a company. Costs £18.

HMRC Self Employed – The self-employment section of the HM Revenue & Customs website, with lots of downloadable guides to the tax system.