Sole trader vs limited company: how the tax compares
Once profits climb, a lot of sole traders wonder whether they'd pay less tax through a limited company. Sometimes they would. But the honest answer is "it depends", and the gap has narrowed since dividend taxes rose and the Corporation Tax rate went up. Here's the shape of the comparison so you can have a sensible conversation about it.
How a sole trader is taxed
As a sole trader, you and the business are the same for tax. You pay Income Tax and Class 4 National Insurance on your profit, whether or not you take it out of the business. It's simple, cheap to run, and the tax is exactly what the estimator shows. The downside at higher profits is that you can't easily control the timing. The profit is taxed as it's earned.
How a limited company is taxed
A company is a separate legal entity. Its profits are taxed with Corporation Tax, and you then extract money as a mix of salary and dividends, each taxed in your own hands:
- The company pays Corporation Tax on its profit (a small-profits rate of 19% up to £50,000, rising to 25% on profits above £250,000, with a taper between).
- You usually take a small salary, often around the National Insurance threshold, which is deductible for the company.
- You take further profit as dividends, taxed at 8.75%, 33.75% or 39.35% depending on your band, with no National Insurance.
The saving, where there is one, comes from avoiding Class 4 National Insurance on the dividend portion and from being able to leave profit in the company and take it out in a later, lower-income year.
Why the gap has narrowed
A few years ago, incorporating saved a clear chunk of tax for many people. Two changes have eroded that: the Dividend Allowance fell from £2,000 to £500, so more of your dividends are taxed, and Corporation Tax rose above the old flat 19% for larger profits. The Class 4 rate cut to 6% also made staying a sole trader relatively more attractive. The result is that the break-even point is higher than it used to be.
The costs beyond tax
A company isn't just a tax decision. It brings real admin: annual accounts filed with Companies House, a company tax return, more bookkeeping, usually higher accountancy fees, and your details on the public register. Money in the company isn't freely yours until you pay it out properly. For some people the extra hassle outweighs a modest tax saving.
Other reasons people incorporate
Tax isn't the only driver. Limited liability, a more established image with certain clients, and easier profit retention for reinvestment all push people toward a company independent of the tax maths.
How to decide
Start by knowing your sole-trader tax precisely. Put your profit into the estimator. Then take that figure to an accountant who can model the company alternative for your specific drawings and profit level. This is one area where a professional's projection genuinely earns its fee, because the answer turns on details a general rule can't capture.