Every self-employed person reaches a point where the question can no longer be avoided: should I incorporate? The answer isn't purely about tax — liability protection, professional perception, banking, mortgage applications, and admin burden all factor in. But tax is usually the number that tips the decision, and for good reason. The difference between sole trader and limited company tax treatment can run to thousands of pounds per year at the right income level.
Let's compare the structures honestly, including the bits that complicate the headline "limited company pays less tax" narrative.
Sole Trader: The Simple Option
As a sole trader, you and your business are legally the same entity. You register with HMRC for Self Assessment, file a tax return each January for the previous tax year, and pay Income Tax and National Insurance on your profits. The structure is simple, cheap to maintain, and requires minimal ongoing administration.
The tax treatment: you pay Income Tax at 20% on profits between the personal allowance (£12,570) and the basic rate band (£50,270), then 40% above that. You also pay Class 4 National Insurance at 6% between £12,570 and £50,270, and 2% above that. Class 2 NI — a flat weekly amount — was abolished from April 2024.
Use our self-employment tax calculator to model your liability at different profit levels as a sole trader. It accounts for the personal allowance, tax bands, and NI contributions.
Limited Company: The Tax-Efficient (But More Complex) Option
A limited company is a separate legal entity. You're a director and shareholder. The company pays Corporation Tax on its profits (19% for profits under £50,000; 25% for profits over £250,000; marginal relief between). You extract your income through a combination of salary and dividends.
The standard limited company tax strategy for owner-managed businesses: pay yourself a salary up to the NI primary threshold (approximately £12,570) to avoid both employee and employer NI while still building NI contribution history. Take the remaining profit as dividends, which are taxed at lower rates than salary — 8.75% within the basic rate band, 33.75% in the higher rate band — after the dividend allowance (£500 per year from April 2024).
The tax saving versus sole trader status at £80,000 profit is typically £4,000-£8,000 per year, depending on how you structure the extraction. This saving diminishes at lower income levels and disappears entirely below roughly £30,000-£35,000 profit, where the accountancy costs outweigh the benefit.
VAT: The Same for Both Structures
VAT registration applies to both sole traders and limited companies equally. Once your taxable turnover exceeds £90,000 in any rolling 12-month period, you must register for VAT, charge it to customers, and file VAT returns. The structure of your business doesn't affect this threshold.
If you're approaching the threshold, understanding whether you should register voluntarily before you're required to is worth considering. Use our VAT calculator to understand how adding 20% VAT to your prices affects competitiveness, and whether the VAT you'd reclaim on purchases makes early registration worthwhile.
The Flat Rate Scheme can simplify VAT accounting for limited companies and sole traders with lower input VAT — worth exploring if your costs don't carry much VAT.
Limited Liability: The Non-Tax Reason to Incorporate
As a sole trader, your personal assets are exposed to business debts and claims. If your business is sued or cannot pay its debts, your personal finances — savings, property — are at risk. A limited company's liability is, in most circumstances, limited to the company's assets.
This matters more for some sectors than others. Consultants with professional indemnity insurance covering their personal liability may find the protection less compelling than, say, a product business with physical goods that could cause harm. But for anyone running a business with material commercial risk, limited liability is a genuine benefit independent of the tax position.
The Costs That Offset the Tax Saving
A limited company requires: annual filing at Companies House, annual confirmation statement, Corporation Tax return (CT600), separate company accounts, registered office address (if you don't want your home address on public record), and almost certainly an accountant. Total running costs of £1,500-£3,500 per year are typical.
At lower income levels these costs erode or eliminate the tax benefit. The general rule of thumb is that incorporation makes financial sense when your profits consistently exceed £30,000-£40,000 per year — though the right threshold depends on your specific circumstances and your accountant's fees.
HMRC's guidance on setting up a limited company covers the registration process and ongoing obligations in full.
The Mortgage Complexity Factor
One frequently overlooked downside of operating through a limited company: mortgage applications become more complex. Lenders assess affordability based on salary plus dividends (some lenders) or salary plus share of profit (others), and some require multiple years of filed accounts. If you plan to buy a property in the near future, speak to a mortgage broker familiar with contractor and director applications before you incorporate.
Making the Decision
Sole trader if: your profits are under £30,000, you want simplicity, you plan to apply for a mortgage soon, or you're testing a business idea before committing. Limited company if: profits consistently exceed £35,000+, liability protection matters, you want the credibility of a registered company, or you're contracting in sectors that routinely require limited company status from suppliers.