For most new or small businesses, operating as a sole trader is simpler and cheaper to run. A limited company offers limited liability and more flexibility over when you draw income, and it can save tax once profits are high enough to leave some money in the business.
The tax gap between the two has narrowed with higher dividend tax rates, so the decision now turns as much on liability, admin and your plans for the profits as on tax alone.
How each is taxed
A sole trader pays income tax on all business profits, whether or not they are drawn out. For 2026/27 that means the £12,570 personal allowance, then 20 percent up to £50,270, 40 percent above that and 45 percent above £125,140. Class 4 National Insurance is also due at 6 percent on profits between £12,570 and £50,270 and 2 percent above.
A limited company pays corporation tax on its profits: 19 percent on profits up to £50,000, 25 percent above £250,000, with marginal relief in between. The owner then pays personal tax only on what is taken out, usually a small salary plus dividends. For 2026/27 dividends are taxed at 10.75 percent in the basic rate band, 35.75 percent at higher rate and 39.35 percent at additional rate, after a £500 dividend allowance.
A worked example
Take a business making £60,000 of profit in 2026/27, with the owner drawing everything out.
As a sole trader:
- Income tax: £7,540 at 20 percent plus £3,892 at 40 percent, total £11,432.
- Class 4 National Insurance: £2,262 plus £195, total £2,457.
- Total tax about £13,890.
As a limited company with one director paid a salary of £12,570 and the rest as dividends:
- Employer National Insurance on the salary: £1,136. The employment allowance is not available where the director is the only employee.
- Corporation tax at 19 percent on the remaining £46,295: £8,796.
- Dividends of £37,499, of which £500 is tax-free: dividend tax £3,977.
- Total tax about £13,910.
At this level, with all profit withdrawn, there is almost nothing in it before the extra costs of running a company. The saving appears when profits are higher and you can leave some in the company, taxed at corporation tax rates, rather than drawing it out at higher-rate dividend tax. The salary level can also be adjusted to reduce National Insurance.
Liability and credibility
A sole trader is personally liable for all business debts. A limited company is a separate legal entity, so in most cases the owner's liability is limited to what they have invested. In practice, banks and landlords often ask directors for personal guarantees, which reduces this protection.
Some customers, particularly larger businesses, prefer to deal with limited companies. A company can also bring in new shareholders more easily, which matters if you plan to grow or sell.
Admin and cost
A company must file annual accounts and a confirmation statement at Companies House, file a corporation tax return, and run payroll for any salary. The accounts are publicly available. Directors have legal duties and must keep company money separate from their own; taking more than you are entitled to creates an overdrawn director's loan account.
A sole trader files a self assessment return and keeps business records. Accountancy fees are usually lower, and the finances are more private.
Making Tax Digital for Income Tax
Sole traders and landlords now face Making Tax Digital for Income Tax. From 6 April 2026 it applies where qualifying income, meaning turnover and gross rents before expenses, was over £50,000 in 2024/25. The threshold falls to £30,000 from April 2027 and £20,000 from April 2028. Those affected must keep digital records, send quarterly updates and file a final declaration by 31 January.
Limited companies are not within Making Tax Digital for Income Tax. That should not be the main reason to incorporate, but it is part of the admin comparison.
Changing structure later
Many people start as sole traders and incorporate once profits grow. Transferring an existing business into a company needs some care, as there can be capital gains tax, VAT and stamp duty land tax points to consider, though reliefs are often available.
What to do
- Estimate your profit for the next two to three years and how much you need to draw.
- Compare the total tax and running costs under each structure.
- Consider how important limited liability is for your type of work.
- If you are a sole trader, check whether Making Tax Digital applies to you and when.
If you would like us to run the numbers for your business, book a free call.
