If you work for yourself, one of the biggest decisions you will face is how to set up your business. Should you stay a sole trader, where you and the business are legally the same thing? Or should you form a limited company, which is a separate legal entity you own and run?
It is not just a tax question, but tax is a big part of it. In 2026/27, the answer depends heavily on how much you earn and how much of that money you actually need to take out. Let us walk through it in plain English.
How a Sole Trader Is Taxed
As a sole trader, your business profit is treated as your personal income. You pay income tax on it at the usual rates — 20%, 40%, or 45% — after your £12,570 personal allowance. On top of that, you pay Class 4 National Insurance on profits above a set threshold.
The upside is simplicity. You report everything through one Self Assessment tax return each year, your accounting is straightforward, and there are no separate company filings. The downside is that once your profits climb into the higher-rate band, your tax bill rises sharply, and you have unlimited liability — meaning your personal assets are on the line if the business runs into debt.
You can estimate your bill as a sole trader using our self-employed tax calculator, and check what you can deduct with our allowable expenses calculator.
A quick sole trader example
Say you make £50,000 of profit as a sole trader. Your first £12,570 is covered by the personal allowance, so you pay no income tax on it. The remaining £37,430 sits in the basic-rate band and is taxed at 20%, giving roughly £7,486 of income tax. On top of that you pay Class 4 National Insurance on profits above the threshold. All of it flows through a single Self Assessment return, and there is nothing else to file. Simple, but every extra pound of profit above £50,270 starts being taxed at 40%, which is where many people begin to wonder whether a company would help.
How a Limited Company Is Taxed
A limited company pays Corporation Tax on its profits, not income tax. For 2026/27, the small profits rate is 19% on profits up to £50,000, rising on a sliding scale to 25% for profits above £250,000.
You then decide how to pay yourself from the company. Most directors take a small salary, often around the National Insurance threshold, and top it up with dividends. Dividends are taxed at lower rates than salary — 8.75% for basic-rate, 33.75% for higher-rate, and 39.35% for additional-rate taxpayers — and they do not attract National Insurance.
This salary-plus-dividends approach is what makes a limited company tax-efficient for many people. Our dividend vs salary calculator shows the most efficient split for your situation, and our sole trader vs limited company calculator compares the two side by side.
The same profit through a company
Take that same £50,000 of profit through a limited company. The company first pays Corporation Tax at 19%, which is £9,500, leaving £40,500 to distribute. You might take a small salary of around £12,570 (covered by your personal allowance) and the rest as dividends. After the £500 dividend allowance, most of those dividends are taxed at just 8.75% in the basic-rate band. The key difference is that none of it attracts National Insurance, which is where the saving really comes from. The exact figures shift with the thresholds each year, but the shape of the answer holds: a company can leave more in your pocket once profits are healthy, provided you do not need to strip every penny out.
Where Is the Break-Even Point?
As a rough guide, a limited company starts to make tax sense once your profits comfortably exceed the personal allowance and you do not need to draw out every penny. Many accountants point to profits of around £30,000 to £40,000 as the level where the savings begin to outweigh the extra cost and admin.
But the saving shrinks if you need to withdraw all the profit to live on, because you then pay dividend tax on top of corporation tax. The biggest gains go to people who can leave some profit in the company to draw out later, or to reinvest in the business.
The Extra Admin of Going Limited
Tax savings are only part of the story. A limited company brings responsibilities that a sole trader simply does not have:
- You must file annual accounts and a confirmation statement with Companies House, and these are public
- You file a separate Corporation Tax return with HMRC
- You will almost certainly need an accountant, which typically costs £1,000 to £2,000 a year
- You have legal duties as a company director that you must take seriously
- Money in the company bank account is not your personal money — you have to pay it to yourself properly
For some people, that extra burden is worth it for the tax saving and the limited liability protection. For others, the simplicity of being a sole trader is worth more than a modest tax cut.
What About VAT and Taking On Staff?
Two questions come up a lot, and the answer to both is the same: your business structure does not change them. VAT registration is compulsory once your turnover passes the threshold (currently £90,000) whether you are a sole trader or a limited company. Below that, you can register voluntarily if it suits you. Either way, the rules are identical.
The same is true of employing people. Both sole traders and companies can take on staff, run a payroll, and deduct PAYE and National Insurance. So if you are wondering whether you need to incorporate before you can grow or hire, the short answer is no. Those decisions stand on their own. Structure mostly affects how you are taxed on the profit, not how the business operates day to day.
Other Things That Tip the Balance
Tax is rarely the only factor. A limited company can look more credible to larger clients, and some contracts are only offered to incorporated businesses. Limited liability means your home and savings are generally protected if the business fails, which matters more in higher-risk trades.
On the other hand, if you work mainly for a single client, you need to be careful about the off-payroll working rules, often called IR35. Our IR35 calculator can help you understand whether those rules might apply to you, because they can wipe out much of the tax advantage of a company.
Switching Later
You are not locked in forever. Plenty of people start as a sole trader to keep things simple, then incorporate once their profits grow and the numbers start to favour a company. Going the other way, from limited back to sole trader, is also possible but a little more involved.
When weighing it all up, it helps to run through a short checklist:
- How much profit do you make, and how much of it do you actually need to live on?
- Can you afford an accountant and the extra admin a company brings?
- Do you work in a higher-risk trade where limited liability would give you peace of mind?
- Do your clients prefer, or require, dealing with a limited company?
- Are most of your contracts likely to fall inside IR35, which would erode the tax benefit?
The Bottom Line
There is no one-size-fits-all answer. If your profits are modest and you value simplicity, staying a sole trader is perfectly sensible. If your profits are healthy, you can leave some money in the business, and you do not mind the extra admin, a limited company can save you a meaningful amount of tax. Run your own figures through our calculators, and if the decision is finely balanced, a short chat with an accountant is money well spent.