Let’s Settle the Debate Once and for All
It’s the question that keeps freelancers and small business owners awake at night. You’re making money, things are going well, and suddenly you’re wondering if you’re doing this whole business structure thing right. Should you stick to the simplicity of being a sole trader, or is it time to level up and incorporate as a limited company?
Honestly, there isn’t a single right answer for everyone. But there is definitely a right answer for you. It comes down to how much profit you’re making, how much admin pain you can tolerate, and how much you want to protect your personal assets from business risks.
We’re going to break this down without the boring textbook definitions. We’ll look at the cold, hard cash differences and the reality of running both structures in the UK for the 2025-26 tax year.
The Sole Trader: Simplicity is King
Being a sole trader is basically business in its rawest form. You and the business are the same legal person. If the business makes money, you make money. If the business owes money, you owe money. It’s incredibly straightforward to set up, and you can usually get going by simply registering for Self Assessment with HMRC.
The beauty here is the lack of red tape. You don’t need to register with Companies House, you have fewer public filing requirements, and your accounting costs are generally much lower. You keep all the profits after tax, and the admin burden is relatively light. For many people starting out or running side hustles, this is exactly where you want to be.
But that simplicity comes with a catch. Because you and the business are one and the same, you have unlimited liability. If things go south and your business builds up massive debts, creditors can come after your personal assets, including your house and car. That sounds scary because it is. You need to weigh that risk against the ease of operation.
The Limited Company: The Tax Efficiency Powerhouse
Incorporating a business changes the game completely. A limited company is its own legal entity. It has a life of its own, separate from you. It can own property, sign contracts, and crucially, incur debt. This provides the “limited liability” protection that gives this structure its name. If the company fails, your personal assets are generally safe, provided you haven’t done anything dodgy as a director.
But let’s talk about the main reason people switch: tax efficiency. As a sole trader, you pay Income Tax and National Insurance on all your profits. In a limited company, the structure allows for smarter planning. You can pay yourself through a combination of a small salary and dividends.
This is where the magic happens. Dividends aren’t subject to National Insurance. While the dividend allowance has shrunk to £500 recently, the overall tax rate on dividends is still lower than Income Tax rates for many people. By taking a salary up to the primary threshold and the rest as dividends, you can often legally lower your overall tax bill compared to being a sole trader earning the same amount.
Let’s Talk Numbers: The Tax Breakdown
You need to understand how the tax actually hits your bank account in both scenarios. If you’re a sole trader, you pay Income Tax at 20%, 40%, or 45% depending on your earnings. On top of that, you’ve got Class 4 National Insurance rates to deal with. You’re looking at paying 6% on profits between £12,570 and £50,270, and then 2% on anything over that upper limit. It’s a direct hit on your profits, and once you start earning over £50,270, that Higher Rate tax really starts to bite.
For a limited company, the tax dance is a bit more choreographed, and getting the order right is crucial. Here’s the key difference: your director’s salary is an allowable business expense. That means it comes off your turnover before the taxman takes his cut. By paying yourself a salary (usually just enough to qualify for State Pension credits but low enough to minimise National Insurance), you actually reduce the profit figure that is liable for Corporation Tax.
Once that salary is deducted, the company pays Corporation Tax on the remaining profit. For the 2025-26 tax year, you’re looking at 19% if profits are under £50,000. If your profits are over £250,000, you pay the main rate of 25%. If you fall somewhere in the middle, you pay a tapered rate. You can check the specific Corporation Tax rates and thresholds directly on the government’s website to see exactly where you land.
After the company has paid its Corporation Tax, the remaining money is yours to distribute as dividends. These are taxed at 8.75% for basic rate taxpayers, jumping to 33.75% for higher rate taxpayers. Even with the extra layer of administration, this salary-plus-dividend combo often results in a lower total tax bill compared to the sole trader route once your profits exceed a certain level.
The Admin Headache: Is It Worth It?
We can’t sugarcoat this part. Running a limited company involves significantly more paperwork. You have statutory obligations to Companies House, including filing an annual Confirmation Statement and annual accounts. You must adhere to strict rules about how you withdraw money. You can’t just dip into the company bank account to buy groceries like you might as a sole trader.
You’ll almost certainly need a dedicated accountant to keep you compliant, which adds to your costs. You also lose a bit of privacy, as your company details and director information are published publicly on the Companies House register. If you hate paperwork and just want to do your job, the sole trader route might be more appealing regardless of the potential tax savings.
When Should You Switch?
There’s a common “tipping point” discussion in the accounting world. Historically, people said if you earn over £30,000, you should incorporate. Today, with changes to Corporation Tax rates and the slashing of the dividend allowance, that threshold has shifted upwards. For many, the tax savings really become significant when profits hit around the £50,000 mark.
However, money isn’t the only factor. You might want to incorporate earlier for credibility. Some big corporate clients simply won’t work with sole traders; they insist on dealing with limited companies. If you’re looking to raise investment or sell the business later, a limited company structure is pretty much essential.
You also need to think about your industry. If you work in a high-risk sector where lawsuits are a real possibility, the liability protection of a limited company is worth paying a bit more for, even if your profits aren’t huge yet. It’s about sleeping well at night knowing your home isn’t on the line.
Making the Call
Choosing between a sole trader vs limited company setup isn’t a life sentence. You can start as a sole trader and incorporate later as you grow. In fact, that’s a brilliant way to keep costs down while you test your business idea. But if you’re already generating solid profits and paying Higher Rate tax, you’re likely leaving money on the table by staying as a sole trader.
Don’t just guess at this. Run the numbers based on your specific forecasted profit. If the tax saving covers the cost of an accountant and leaves you with a nice surplus, it’s probably time to incorporate. If the difference is marginal, stick to the simplicity of being a sole trader for another year.
If you decide incorporation is the right path, the process is handled through Companies House. You can find the official registration portal here to get started. Whatever you choose, own the decision and focus on what really matters—building a brilliant business.
