For most small businesses in 2026/27, the honest answer in the sole trader vs limited company decision is that liability and retained profit decide it, not a headline profit figure. If you take every pound out of the business to live on, a sole trader can now come out slightly ahead of a limited company. If you leave a good share of the profit in the business, or you carry real risk, or your clients insist on a company, incorporating usually wins. Making Tax Digital for Income Tax applies to sole traders and landlords, not to limited companies.
This UK guide sets out the pros and cons of each business structure, works the numbers through an example, and says when it is worth moving from one to the other.
The difference between a limited company and a sole trader
GOV.UK describes the choice this way: a sole trader is the simplest business structure to set up and keep records for, and a limited company is legally separate from the people who own it and is run by one or more directors. Most small business owners pick one of these two, and the company structure you choose affects how you pay tax and what you are legally responsible for.
| Sole trader | Limited company | |
|---|---|---|
| Legal identity | You and the business are the same | The company is a separate legal entity |
| Debts | You are personally responsible for all of them | Owners are responsible only up to the value of their investment |
| Tax on profit | Income Tax and National Insurance through Self Assessment | Corporation Tax on the company, then tax on what you take out |
| Annual filing | One Self Assessment return | Accounts, a confirmation statement and a Company Tax Return, plus usually your own personal return |
| Privacy | Accounts stay private | Accounts and confirmation statement are public at Companies House |
| Taking money out | Withdraw what you like | Salary, dividends or a director's loan, each with rules |
| Cost to set up | Free | £100 to incorporate online |
Two terms are worth fixing before going further. Unlimited liability means a sole trader's owner is personally responsible for all of the business's debts. Limited liability means a company's owners are responsible for its debts only up to the value of what they have put in. A limited company is a separate legal entity, which is why it can own assets, sign contracts and owe debts in its own right.
Sole trader tax: income tax and National Insurance
Sole traders pay Income Tax on the profit of the business, and that profit is taxed whether or not they draw it out. The profit goes on the Self Assessment return and HMRC works out the tax and National Insurance contributions from there.
For 2026/27 in England, Wales and Northern Ireland the tax rates and bands are:
- a personal allowance of £12,570;
- 20% on income up to £50,270;
- 40% from there up to £125,140;
- 45% above £125,140.
The personal allowance is withdrawn by £1 for every £2 of income over £100,000, so it has gone completely by £125,140. Class 4 National Insurance is 6% on profits between £12,570 and £50,270 and 2% on profits above that. In Scotland the Income Tax bands differ, so check them separately.
Sole traders also have a few reliefs a company cannot use. The trading allowance (a tax exemption of up to £1,000 a year), cash basis accounting by default, and flat-rate simplified expenses for things like working from home and vehicle costs are all unavailable to limited companies. A sole trader who makes a loss may also be able to set it against other income, such as employment income. A company can only use its losses against its own profits.
Limited company tax: Corporation Tax and dividend tax
Limited companies pay Corporation Tax on profits before the owner sees any of it. GOV.UK sets out the company tax rates:
- 19% (the small profits rate) if profits are £50,000 or less;
- 25% (the main rate) if profits are over £250,000;
- Marginal Relief between £50,000 and £250,000.
Marginal Relief is not a middle rate. In practice it produces an effective marginal rate of 26.5% on each pound of profit between £50,000 and £250,000. The £50,000 and £250,000 limits are also reduced for short accounting periods and for associated companies.
Then you are taxed again personally on what you take out, usually as a mix of salary and dividends. Salary is subject to PAYE and National Insurance. Dividends fall within a £500 tax-free dividend allowance, and dividend tax applies above that. In the 2026/27 example below, the dividend rates are 10.75% in the basic-rate band and 35.75% in the higher-rate band.
One trap catches single-director companies. The £10,500 Employment Allowance against employer National Insurance is not available if the company has one director and that director is the only employee liable for secondary Class 1 National Insurance. A one-person company with no other staff therefore pays employer National Insurance in full.
A worked example at £70,000 of profit
Take a business making £70,000 a year where the owner needs to draw all of it.
As a sole trader, using the 2026/27 figures above:
- Income Tax: £37,700 at 20% is £7,540, and the remaining £19,730 at 40% is £7,892. That is £15,432.
- Class 4 National Insurance: £37,700 at 6% is £2,262, and £19,730 at 2% is about £395. That is about £2,657.
- Total about £18,089, leaving roughly £51,911.
Through a company, a worked example from a UK accountancy firm for the same profit, fully extracted as salary and dividends, puts the combined tax and National Insurance across the company and the individual at £18,958, leaving £51,042.
The sole trader is therefore about £870 a year better off, and that is before the company incurs any extra accountancy or filing cost. At the dividend rates in force before April 2026 the two structures would have come out level. The tax savings from incorporating at this level of profit have weakened, and the tax efficiency of a limited company is no longer automatic.
That comparison is only half the story, because it assumes you take everything out.
Why retained profit changes the answer
Suppose £30,000 of profit is meant to buy stock, a van or a hire. As a higher-rate sole trader, that £30,000 costs a marginal 42% (40% Income Tax plus 2% Class 4), or £12,600, even though it never leaves the business account. Between £100,000 and £125,140 of profit the effective rate reaches 62%, because the personal allowance is being withdrawn at the same time.
Inside a company, the same £30,000 left in the business is taxed only at Corporation Tax: £5,700 at 19%, or £7,950 if it falls in the 26.5% marginal band. A second layer of tax arrives only if and when you pay yourself a dividend.
This gap is the strongest financial argument for incorporating, and the most tax efficient route only exists if you really are reinvesting. The accountancy firm behind the worked example above suggests that if you will leave more than roughly £15,000 to £20,000 in the business over the next year and you are a higher-rate taxpayer, the gap starts to outweigh the extra running cost quickly. Ask how much will stay in the business before you ask what your turnover is. If you are a contractor weighing salary against dividends, our piece on salary and dividends for contractors in 2026-27 goes into the mechanics.
Do you pay more tax as self-employed or through a limited company?
It depends on how much you take out and how much you keep in. If you extract all the profit, as in the £70,000 example, a sole trader pays slightly less in 2026/27 once the cost of running a company is added. If you leave profit in the business, limited companies usually pay less tax, because retained profit is taxed at 19% or a marginal 26.5% rather than 42% for a higher-rate sole trader. There is no single answer without your own figures, which is why the tax implications should be calculated rather than guessed.
Admin and filing: what a company adds
A sole trader registers for Self Assessment if they earn more than £1,000 in a tax year (6 April to 5 April), keeps records of income and expenses, and files one return. The accounts are not sent to HMRC unless there is an investigation, and there is nothing to file at Companies House. Sole traders generally make Income Tax payments on account; limited companies generally do not.
Limited companies have more to do each year:
- Statutory annual accounts, filed at Companies House. HMRC requires full accounts for Corporation Tax, submitted online in iXBRL format.
- A Company Tax Return to HMRC.
- A confirmation statement, which costs £50 a year at Companies House.
- Payroll under PAYE if you take a salary. The company must register as an employer and report to HMRC in real time each time it pays someone.
- Records of dividends and board decisions, typically board minutes and a dividend voucher.
- Your own personal tax return as director, which you will nearly always still need.
The direct fees are small. Companies House charges £100 to incorporate online, and a formation agent or accountant typically charges around £150 for doing it for you. The real cost is professional time. In one accountancy guide's experience, fees for a sole trader are usually 30% to 50% lower than for a company. On a £70,000 profit the fee difference can be larger than the tax difference, so put your accountant's quote for each structure beside the tax figures.
Taking money out of a company
A sole trader can withdraw cash from the business with no tax effect, because the profit has already been taxed. A director cannot treat the company account as their own. You take money out as salary, as dividends, or as a director's loan.
Directors' loans are allowed under the Companies Act 2006, but they carry tax costs. If you borrow from the company and do not repay the loan within nine months of the year-end, the company pays a tax charge of 35.75% of the loan (this was 33.75% up to 5 April 2026). If the loan is interest-free, there is also a beneficial loan charge for the director.
On pensions, a sole trader can have a personal pension. A company can make employer contributions, which are often more flexible. How a mortgage lender treats a sole trader compared with a company director depends on the lender, so ask before you incorporate if you are about to apply.
Expenses differ too. A company can provide a mobile phone tax-free if the contract is in the company's name, and can provide a computer you need for your role without tax consequences. A sole trader must add back any private use. For working from home, a sole trader can claim a deduction for mortgage interest, rates, light and heat for a home office, whereas a company can reimburse light and heat but not mortgage interest or council tax.
Liability: what protection you actually get
This is often the biggest factor, and it can outweigh the tax comparison. A sole trader's personal assets, such as a home or savings, can be reached by business creditors. A company's creditors can generally pursue only the company's assets.
The protection has limits:
- Personal guarantees. If you guarantee company borrowing, you are liable under that guarantee.
- Wrongful trading. A director can be held personally accountable for continuing to trade while the company is insolvent if that causes loss to creditors.
- Fraud and deliberate tax behaviour. Directors can be personally liable where they commit fraud, deliberately avoid tax or deliberately conceal matters.
- Specific offences, such as under health and safety, environmental or companies legislation.
Directors also carry legal duties, including safeguarding the company's assets and deciding to stop trading if you know the company cannot survive. Failing in these can bring fines or even prison. Whichever structure you use, insurance still matters. GOV.UK notes that both a sole trader and a company may need additional business insurance, and a limited company employing staff is legally required to hold Employers' Liability insurance.
Sole trader pros and cons
The advantages are real for a small business. Setup is free, there is less admin, accountancy and compliance costs are usually lower, and your accounts remain private. You keep all the profits after paying tax and make every decision yourself.
The disadvantages are worth listing plainly, since people often search for them. A sole trader faces:
- Unlimited liability for business debts, including exposure of your home and savings.
- Credibility problems with some clients and sectors, particularly regulated industries such as finance.
- Harder access to finance. Lenders may require personal guarantees.
- Less tax planning. Once profits rise, a company combining salary and dividends can be more tax efficient.
- Limited pension routes, being restricted to personal pensions.
- No dividends, which limits how you can structure extraction.
- Difficulty raising capital. Some forms of finance need a business to issue shares, which means restructuring into a company.
- Insurance burden, because personal risk makes public liability or professional indemnity insurance often essential.
- Sole responsibility for sales, marketing, accounting and administration.
- Succession problems, because a sole trader business usually ends when the owner retires or closes it, with only the assets or goodwill transferable.
Limited companies: advantages and disadvantages
The advantages: limited liability, possible tax savings, easier investment through shares, and continuity, since a company can carry on if the owner steps back and is easier to sell or pass on. The disadvantages: more paperwork, public records, legal duties as a director, higher accountancy costs, stricter rules for taking money out, and more complexity if you want to stop trading.
On privacy, the company's accounts and confirmation statement are public, including its office address, though that address can be your accountant's rather than your home. A sole trader's earnings stay private unless they choose to share them.
On credibility, some clients prefer limited companies, and for some work incorporation is a contractual requirement. Contractors, surveyors and financial services businesses are typical examples. Local trades, retail and small service businesses are normally entirely comfortable as sole traders. Some larger organisations and public bodies will not contract with an unincorporated supplier, which is a factual question you can put to your client.
So are limited companies always better? No. A limited company structure suits some businesses and costs others money, as the £70,000 example shows.
Making Tax Digital for Income Tax
Making Tax Digital (MTD) for Income Tax applies to sole traders and landlords. Limited companies are outside it, and the government has no plans to introduce MTD for Corporation Tax.
It began on 6 April 2026 for people with qualifying income over £50,000. The threshold falls to over £30,000 from 6 April 2027 and to over £20,000 from 6 April 2028. If you are caught, you send quarterly digital updates to HMRC using compatible software instead of relying on a single annual return, which is a real change in working habit. HMRC defines what counts as qualifying income, so check your own position against its guidance rather than assuming turnover and profit are interchangeable.
MTD is not a reason to incorporate on its own, but it belongs in the comparison, particularly if your income is heading toward £30,000 or £20,000 and you would otherwise fall into scope in the next two years.
VAT works the same for both. You must register if taxable turnover reaches £90,000, and you can register earlier if you want to reclaim VAT on business purchases.
When to switch from sole trader to limited company
There is no single profit figure that settles it. A commonly quoted rule of thumb is that incorporating becomes worthwhile at around £25,000 to £30,000 of profit. That pre-dates the 2026/27 dividend rates, and as the £70,000 example shows, a business that takes all its profit out may not gain at all. A better test, in order:
- Do you carry real liability risk? Physical work on other people's property, products that could injure someone, contracts with large damages clauses, or employees. If yes, limited liability can justify incorporating by itself.
- Do your customers require it? Ask them.
- How much profit will you leave in the business over the next 12 months? If it is above roughly £15,000 to £20,000 and you are a higher-rate taxpayer, the company starts to pay.
- Are you raising investment or bringing in a co-owner in the next two years? A company can issue shares to investors; a sole trader cannot readily do this without first becoming a partnership. Incorporate before the negotiation, not during it.
If none of these gives a clear yes, you can operate as a sole trader for another year, and that is a perfectly sound answer. It is also cheaper than incorporating and later unwinding the decision.
How to form a limited company and switch from a sole trader
GOV.UK says it is usually easier to move from sole trader to limited company than the other way round. To set up a limited company when you switch from sole trader status:
- Choose a company name and register the company at Companies House. The name must be unique and not already in use by another company, and GOV.UK sets rules on what you can call a business.
- Tell HMRC about the change and register the company for Corporation Tax.
- Transfer the business assets, such as equipment, stock and goodwill, to the company.
- Open a business bank account in the company's name.
- Tell clients, suppliers and others, and reissue contracts, insurance and licences in the company's name.
Two points catch people out. First, the sole trader business legally ceases, so you file a final Self Assessment return for the period to cessation. Second, transferring the assets is itself a taxable event, although incorporation relief can defer a gain where the whole business goes across in exchange for shares. Your VAT registration does not follow automatically: you either register the company afresh or apply to transfer the existing number.
If you are setting up as a contractor, our walk-through of the first 30 days of a contractor company covers the practical order of events.
Closing a company and going back to sole trader status
Going back is more involved than moving in. You stop trading through the company, settle its liabilities, extract any remaining value, which may be taxed as a distribution, and then either strike the company off or place it into a members' voluntary liquidation, depending on how much is left. Extracting reserves on a wind-up can sometimes be taxed as capital rather than income, which is why the order of events matters and why it is worth planning rather than improvising.
Whether you are better off closing the company depends on whether the reasons you incorporated still apply. If the business has become simpler or smaller and you no longer retain profit, the extra admin may no longer earn its keep.
Selling the business also differs. A sole trader is taxed on gains under Capital Gains Tax. On a company sale, the company pays Corporation Tax on any profit on the disposal and the shareholders are taxed again on the proceeds. Business Asset Disposal Relief can apply on gains of up to £1 million over a lifetime, where you own more than 5% of a trading company.
Frequently Asked Questions
Do I pay myself a salary as a sole trader?
No. A sole trader takes drawings from the business, and the whole profit is taxed as your income whether or not you withdraw it. A company director normally takes a salary, dividends or both.
When should I go from sole trader to limited company?
When real liability risk, a client requirement, outside investment, or a meaningful amount of profit you will retain makes the extra admin worthwhile. A profit figure on its own is not a reliable trigger.
Does Making Tax Digital apply to my limited company?
No. MTD for Income Tax applies to sole traders and landlords. If you are a sole trader with qualifying income over £50,000, you have been in scope since 6 April 2026.
Can I be both a director and a shareholder of a limited company?
Yes. A shareholder owns all or part of the company's share capital, and a director serves the company as an officer. In a one-person company the same person usually holds both roles.
Can I go back to being a sole trader later?
Yes, but it takes more work than incorporating. You wind down the company, settle its liabilities and deal with the tax on any value you extract.
Getting help with the decision
Deplexify prepares accounts and tax for UK businesses, contractors, landlords and charities. If you want your own figures run through both structures, or help with the set-up, the details are on our UK accounting page.
Sources
- Set up a business - GOV.UK — gov.uk, read 2026-10-18
- Become a sole trader: What a sole trader is - GOV.UK — gov.uk, read 2026-10-18
- Corporation Tax rates, expenses and reliefs: Rates - GOV.UK — gov.uk, read 2026-10-18
- Sole trader or limited company: which is best for you? - FreeAgent — freeagent.com, read 2026-10-18
- Sole trader v. limited company: Key tax & legal differences - www.rossmartin.co.uk — rossmartin.co.uk, read 2026-10-18
- Ltd vs Sole Trader: Key Differences and Considerations - Hibberts Solicitors — hibberts.com, read 2026-10-18
- Choose Between Sole Trader vs Limited Company - HSBC UK — business.hsbc.uk, read 2026-10-18
- Sole Trader vs Limited Company: What Changes | Buzz — buzzaccounting.co.uk, read 2026-10-18
- Sole trader vs limited company – pros and cons explained - ByteStart — bytestart.co.uk, read 2026-10-18