The question of sole trader tax vs limited company comes up in almost every initial conversation we have with growing businesses. Someone hits a decent level of income, a friend tells them they should incorporate, and suddenly they’re wondering whether they’re leaving money on the table by staying as a sole trader.

Sometimes they are. Sometimes they’re not. The honest answer is that the tax difference is real — but it’s not a reason to incorporate on its own, and it becomes meaningful at specific profit levels rather than the moment you start trading.

This post sets out how the two structures are taxed, where the gap actually opens up, and the things beyond tax that tend to make the decision clearer one way or the other.

As a sole trader, you’re taxed on your profits — that’s your income minus your allowable business expenses. Those profits are reported through a Self Assessment tax return each year, and you pay Income Tax and National Insurance on them.

The rates work like this: your first £12,570 of profit is covered by the personal allowance and taxed at zero. Profits between £12,570 and £50,270 are taxed at 20% Income Tax, plus Class 4 National Insurance at 6%. Once profits go above £50,270, you hit the higher rate — 40% Income Tax — and the NI rate drops to 2% above that threshold.

There’s also Class 2 NI, though for most sole traders this is now factored into Self Assessment rather than a separate payment.

The key point: every pound of profit you make is personal income, taxed in the year you make it. There’s no deferring it, no splitting it with a spouse or partner through shares, and no choosing to leave some inside the business at a lower rate. What the business earns, you earn — immediately and in full.

For lower profit levels, that simplicity is actually a feature. There’s less admin, no corporation tax filing, no Companies House obligations, and the tax position is straightforward to manage.

A limited company is a separate legal entity from you personally. It pays Corporation Tax on its profits — currently 19% for companies with profits under £50,000 (the small profits rate), rising on a sliding scale up to 25% for profits over £250,000.

As a director, you extract money from the company in two main ways: salary and dividends. The typical approach is a low salary set around the National Insurance threshold (roughly £12,570 for the 2025/26 tax year) and the rest taken as dividends. Dividends are taxed at lower rates than salary — 8.75% within the basic rate band, and 33.75% in the higher rate band — though the dividend allowance has now dropped to just £500, so most dividend income will be taxable.

The tax efficiency comes from two places: first, profits left inside the company are only subject to Corporation Tax, not the combined Income Tax and NI burden of a sole trader. Second, the salary and dividend split generally reduces your overall tax and NI liability compared to taking equivalent profits as a sole trader at the same level.

That said, limited companies carry real administrative obligations: annual accounts, a confirmation statement filed at Companies House, a Corporation Tax return, and payroll if you run a salary. That’s more work and, typically, a higher accountancy fee.

This is the part that tends to surprise people. At lower profit levels, the tax saving from incorporating can be modest — sometimes not enough to justify the extra complexity and cost.

As a rough principle, the tax efficiency argument for a limited company starts to become meaningful once you’re consistently taking home profits of around £30,000 to £35,000 or more, and it becomes more compelling as profits grow beyond that. At lower levels, the additional accountancy fees and administrative burden can eat into or even wipe out any tax saving.

There are other scenarios where incorporation makes sense earlier:

• You want to retain profits in the business — leaving money in the company rather than drawing it all out means it’s only taxed at the Corporation Tax rate until you extract it.
• IR35 applies to your work — if you’re a contractor, the IR35 rules affect whether you can benefit from a limited company structure at all, and the decision becomes more nuanced.
• Liability is a concern — sole traders have unlimited personal liability; limited companies provide a layer of protection between your business debts and your personal finances.

We’d also gently push back on the idea that incorporation is something you should do as early as possible. The administrative overhead is real, and for a business in its first year or two, keeping things simple often serves you better.

If you do decide to incorporate, the process is more involved than simply opening a new company. You’ll need to close down your sole trader registration with HMRC, register the limited company for Corporation Tax with HMRC, and re-register for VAT and PAYE under the new company if applicable.

The VAT threshold applies to both structures equally — once your turnover exceeds £90,000 in a rolling 12-month period, you must register for VAT regardless of whether you’re a sole trader or a limited company.

One thing people underestimate is the timing. You’ll have a final sole trader tax return to file, and your new company will have its own accounting period from day one. If you’ve been trading for a while, there may be overlap to manage carefully — particularly around stock, equipment, and any work in progress at the point of incorporation.

We handle this kind of transition regularly and it’s manageable with decent planning. The problems tend to arise when people incorporate in a hurry without thinking through what moves across and what doesn’t.