Sole Trader vs. Limited Company: Which Structure is best for Tax?

When embarking on your entrepreneurial journey, or even if you are an established business, a crucial decision is your business structure: will you operate as a sole trader or a limited company? This choice isn’t just about legal formalities; it carries significant weight regarding your personal liability, administrative burden, and, perhaps most importantly, the tax you will pay. Let’s delve into the tax implications of each option to help you make an informed decision on how best to structure your business.

Sole Trader: Tax Implications

As a sole trader, there’s no legal distinction between you and your business, however this simplicity has tax consequences:

All profits your business generates are treated as your personal income. You will pay Income Tax on these profits according to the prevailing income tax bands in the UK. This means that as your profits increase, you could move into higher tax brackets (currently ranging from 20% to 45%). You are required to submit a Self-Assessment tax return (SA100) annually to HMRC, detailing your business income and expenses.

As a self-employed individual, you are also likely to need to pay National Insurance, the rate of this has reduced in recent years and now stands at 6% in 2025/26 for profits above £12,570. Class 2 NIC was abolished as a mandatory requirement from the 2024/25 tax year, offering a further tax saving for sole traders.

If your business makes a loss in a tax year, you can offset these losses against your other income in the same tax year or carry them forward to offset future profits in most cases.

Limited Company: Tax Implications

A limited company is a separate legal entity, offering different avenues for profit extraction and taxation.

The company itself pays Corporation Tax on its taxable profits. The current main rate of Corporation Tax in the UK is 25% for profits over £250,000, with a small profits rate of 19% for profits up to £50,000 and a tapered rate in between. This can be a lower initial tax rate compared to higher personal income tax brackets.

However, you will also need to decide how best to pay yourself as a director and often a shareholder of the company. The two main ways of profit extraction are via salary and dividends.

You can draw a salary from the company, which can be subject to Income Tax and National Insurance Contributions (PAYE) for both you (employee’s NICs) and the company (employer’s NICs). Often, directors aim for a salary level that optimises tax efficiency, considering personal allowances and NIC thresholds.

Profits remaining after Corporation Tax can be distributed to shareholders as dividends. Dividends are taxed at different rates depending on your personal income tax band (for the 2025/2026 tax year: Ordinary rate 8.75%, Higher rate 33.75%, Additional rate 39.325%). There is an annual dividend allowance (£500 for the 2025/2026 tax year) that is tax-free.

The Tax Trade-off

Whilst as a Limited company you face Corporation Tax and more complex administration, a limited company offers greater flexibility in how you extract profits, potentially leading to a lower overall tax burden, especially as profits grow. The ability to control the mix of salary and dividends can be a significant tax planning advantage in the long term.

However, with the reductions in class 4 National Insurance, abolition of mandatory Class 2 National Insurance payments and the rises in Corporation Tax rates for profits above £50,000 for many, continuing to operate as a sole trader will result in a smaller tax bill overall.

There are of course many other considerations besides just tax to account for when weighing up the business structure that works best for you, not least the increased administrative burden of operating a Limited company; but at Rogers Spencer we’re here to help you make the most informed decision which best fit your individual circumstances.

If you require more specific advice or have any questions regarding these matters, feel free to get in touch and our team will happily help!

Robin Maxwell

Robin Maxwell is a partner of Rogers Spencer and has been working with us since 2003. Robin specialises in Accountancy Solutions, Audits and Tax and VAT. Find out more about Robin here.