“Should I start a limited company?” is one of the questions we are asked most often. The tax saving from incorporating is smaller than it was a few years ago, so the sole trader vs limited company decision now rests as much on liability, credibility and how much profit you keep in the business as on tax. Here is how a sole trader or limited company is taxed in the UK in 2026/27, and the questions that tend to settle it. The Budget on 28 October 2026 may change some of the figures below, and we will review this article after it.
How a sole trader is taxed
Your profit is simply your income, taxed through Self Assessment:
- Income tax (England, Wales and Northern Ireland): nothing on the first £12,570 (the personal allowance), 20% from £12,571 to £50,270, 40% to £125,140, and 45% above that. The allowance is reduced by £1 for every £2 of adjusted net income over £100,000, and the rates and bands differ in Scotland.
- Class 4 National Insurance: 6% on profits between £12,570 and £50,270, and 2% above.
- Class 2 National Insurance is no longer compulsory. If your profits are £7,105 or more you are treated as having paid it, which protects your State Pension record; below that you can pay voluntarily at £3.65 a week.
It is one calculation, once a year, with no distinction between what the business earns and what you take out.
How a limited company and its director are taxed
The company is a separate legal person, so there are two layers.
The company pays corporation tax on its profits: 19% where profits are £50,000 or less and 25% where they exceed £250,000. Marginal relief applies between those limits, so the rate rises gradually rather than jumping. Both limits are divided between associated companies (broadly, companies under common control), and reduced proportionately for an accounting period shorter than 12 months.
You then pay tax on what you take out, usually a mix of salary and dividends:
- Salary is a deductible cost for the company, but it carries National Insurance on both sides: employer National Insurance at 15% on pay above £5,000 a year, and employee National Insurance at 8% on pay between £12,570 and £50,270, then 2% above that. The Employment Allowance can cut an eligible employer’s bill by up to £10,500 a year, but not where the only employee liable for employer National Insurance is a director, and it can be claimed only once across a group of connected companies. That is why many owner-managers take a modest salary and the rest as dividends.
- Dividends come out of profit that has already borne corporation tax, and they carry no National Insurance at all, unlike a sole trader’s profits, which bear Class 4 on top of income tax, and unlike salary, which bears National Insurance twice over.
- The dividend rates. The first £500 is covered by the dividend allowance. Dividends are taxed as the top slice of your income, so your other income decides which band applies. Above the allowance, the 2026/27 rates are 10.75% at the basic rate, 35.75% at the higher rate and 39.35% at the additional rate. The first two rose by two percentage points on 6 April 2026, narrowing the gap between the structures. These rates apply across the whole UK, including Scotland, where the rates and bands on earned income differ.
Money left in the company is not taxed again until it is drawn, which is where a company keeps an edge if you do not need all the profit. That is a deferral rather than a saving: the second layer arrives when you draw the money or wind the company up. Nor can you simply borrow it in the meantime: taking money out as a loan leaves you owing the company, which is what an overdrawn director’s loan account means, and if the balance is still outstanding nine months after the year end, the company may become liable to the corporation tax charge that applies to overdrawn director’s loan accounts.
The costs beyond tax
A company costs more to run, and it is fair to count that:
- Incorporation: £100 Companies House fee to form the company online. Our company formation service starts from £350 plus VAT, which includes that fee.
- An annual confirmation statement (£50 online, payable once in each 12-month period however many statements you file) and statutory accounts filed at Companies House, on public record.
- A corporation tax return in addition to your personal one, payroll if you draw a salary, and identity verification for every director and person with significant control, which is free to do through GOV.UK One Login but is now a legal requirement.
- Corporation tax is due 9 months and 1 day after the year end, while a sole trader pays through Self Assessment with payments on account.
- Higher accountancy fees, reflecting the extra filings.
The questions that decide it
- Do you need all the profit personally? If you can leave money in the business to reinvest, that deferral is worth having. If you draw everything, the advantage shrinks.
- How exposed are you? A sole trader is personally liable for the business’s debts. A company’s debts are normally its own, and as a shareholder you cannot be asked for more than any amount still unpaid on your shares. That is not the same as having no personal exposure: a personal guarantee is a promise you give in your own name, money you owe on a director’s loan account is yours to repay, and a director can be held personally liable for dividends the company could not lawfully pay or for wrongful or fraudulent trading. In some trades the limit alone settles it.
- Who are your customers? Some clients prefer to contract with a limited company. If the work would make you their employee were you engaged directly, the off-payroll working rules, commonly called IR35, come into play. HMRC’s aim for those rules is that a contractor “pays broadly the same Income Tax and National Insurance as an employee would”, so much of the tax advantage of that engagement is removed. Who does what depends on the client’s size: a public sector body, or a medium or large private client, decides your employment status, and whoever pays your company deducts Income Tax and National Insurance before paying the rest across. If the client is small, that decision stays with your own company. GOV.UK sets out the size test that decides which applies.
- Are you likely to bring in a partner, investor or family member? Shares make that straightforward; a sole trade does not.
- Do you want the admin? A company means more deadlines, and more discipline about keeping company and personal money apart.
A note on Making Tax Digital
MTD for Income Tax applies to sole traders and landlords, not to companies. It has applied since 6 April 2026 where qualifying income was over £50,000 in 2024/25, applies from 6 April 2027 where it was over £30,000 in 2025/26, and is due to apply from 6 April 2028 where it was over £20,000 in 2026/27. Qualifying income is self-employment and property income before expenses, taken from your previous year’s return, not your profit. Partnerships are to follow. It is not a reason to incorporate in itself, but it is one more factor.
When should I incorporate?
There is no profit figure at which incorporating automatically pays. As a rule of thumb, the question is worth a proper look once profits are consistently above the point where higher-rate income tax begins, which means income over £50,270 in England, Wales and Northern Ireland and over £43,662 in Scotland, or once the business is regularly keeping back profit you do not need to draw. Treat that as a prompt to review the numbers, not a recommendation: the decision depends on far more than tax.
We model both structures on your own figures, including what you need to draw, before suggesting either. If you are already a sole trader, a review of your current numbers is the place to start.
How we can help
3DOM.uk works with sole traders, landlords and limited companies across the Wirral, Liverpool and the wider UK, from personal tax returns and planning to corporation tax and planning for company directors. Fixed monthly fees agreed in advance. Book a free consultation.
Figures checked against GOV.UK and Companies House on 23 October 2026 and reflect the 2026/27 tax year. The Budget on 28 October 2026 may change some of them. This article is general guidance, not advice for your specific circumstances.