Sole trader vs limited company 2026/27: which is more tax efficient now the dividend rates have risen?

The picture has changed for 2026/27

For years, the standard advice for any UK business owner with profits above about £25,000 was 'incorporate, it saves tax'. For 2026/27, that advice needs revisiting. The dividend tax rates rose by 2 percentage points on 6 April 2026 (basic rate 10.75%, higher rate 35.75%), and the personal allowance remains frozen at £12,570. Combined, these changes have materially narrowed the limited company advantage and, at some profit levels for a single-director extractor, reversed it entirely.

This article runs the numbers honestly for three common profit levels in 2026/27 and shows where each structure wins.

How sole trader is taxed

A sole trader pays:

• Income tax on profit above the £12,570 personal allowance: 20% basic, 40% higher, 45% additional
• Class 4 National Insurance: 6% on profits between £12,570 and £50,270, 2% above
• Class 2 NI is no longer charged for most sole traders since April 2024

All trading profit is taxable in the year it arises, regardless of whether you have drawn the cash. There is no separation between business and personal finances at the tax level.

How a limited company is taxed

A limited company pays:

• Corporation tax on company profit: 19% up to £50,000, 25% above £250,000, marginal relief between
• Employer National Insurance (15%) on any salary paid to directors above the £5,000 secondary threshold
• The director pays income tax + employee NI on the salary
• The director pays dividend tax (10.75% / 35.75% / 39.35%) on any dividends drawn from after-CT profit, above the £500 dividend allowance

The owner has two extraction levers (salary and dividends), and a third option, retaining profit in the company, that a sole trader does not have.

Worked example: £40,000 profit, single owner extracting it all

Sole trader route

• Taxable profit: £40,000
• Income tax: (£40,000 − £12,570) × 20% = £5,486
• Class 4 NI: (£40,000 − £12,570) × 6% = £1,646
• Total tax: £7,132
• Net cash retained: £32,868

Limited company route (single director, no Employment Allowance)

• Pre-tax profit: £40,000
• Less: director salary £12,570
• Less: employer NI on salary (£12,570 − £5,000) × 15% = £1,135.50
• Taxable company profit: £26,294.50
• Corporation tax at 19%: £4,996
• After-CT profit available for dividend: £21,298.50
• Personal tax on dividend: £500 allowance + £20,798.50 at 10.75% = £2,236
• Net cash to director: £12,570 salary + £21,298.50 dividend − £2,236 dividend tax = £31,632

At £40,000 profit, the sole trader keeps roughly £1,200 more. The limited company structure does not beat sole trader at this level for a single extractor.

Worked example: £60,000 profit

Sole trader route

• Income tax: £37,700 × 20% + £9,730 × 40% = £7,540 + £3,892 = £11,432
• Class 4 NI: £37,700 × 6% + £9,730 × 2% = £2,262 + £195 = £2,457
• Total tax: £13,889
• Net cash retained: £46,111

Limited company route (single director)

• Pre-tax profit: £60,000, less salary £12,570, less employer NI £1,135.50
• Taxable company profit: £46,294.50
• Corporation tax at 19%: £8,796
• After-CT dividend pool: £37,498.50
• Personal tax: £500 allowance + £36,998.50 in basic rate at 10.75% = £3,977
• Net cash to director: £12,570 + £37,498.50 − £3,977 = £46,092

At £60,000 profit, the structures are effectively a tie. The difference is around £20 in favour of sole trader before any company admin costs are considered. Once you add the ~£1,000+ a year in accountancy and filing costs that a limited company carries, the sole trader is comfortably ahead.

Worked example: £100,000 profit

Sole trader route

• Income tax: £37,700 × 20% + £49,730 × 40% = £7,540 + £19,892 = £27,432
• Class 4 NI: £37,700 × 6% + £49,730 × 2% = £2,262 + £995 = £3,257
• Total tax: £30,689
• Net cash retained: £69,311

Limited company route (single director)

• Pre-tax profit: £100,000, less salary £12,570, less employer NI £1,135.50
• Taxable company profit: £86,294.50
• Corporation tax (marginal relief band): £50,000 × 19% + £36,294.50 × 26.5% = £9,500 + £9,618 = £19,118
• After-CT dividend pool: £67,177
• Personal tax on dividend: £500 allowance + £37,200 basic at 10.75% (£3,999) + £29,477 higher at 35.75% (£10,538) = £14,537
• Net cash to director: £12,570 + £67,177 − £14,537 = £65,210

At £100,000 profit, the sole trader is around £4,100 better off than a single-director limited company extracting everything. The April 2026 dividend rate rise tipped this comparison: in 2024/25 with 8.75%/33.75% rates, the limited company would have won at this level by around £2,000.

Why the limited company can still win

The single-director, single-shareholder, extract-everything model is the worst-case scenario for the limited company in 2026/27. Three modifications change the picture substantially:

1. Spousal share splitting

If a non-earning spouse is gifted a share of the company, dividends can be paid to both shareholders. Each spouse uses their own basic-rate band, so most of the dividend income stays in the 10.75% band instead of crossing into 35.75%.

Worked: at £100,000 profit, splitting dividends 50:50 between two basic-rate-only shareholders results in personal tax of roughly £7,200 total instead of £14,500, lifting the limited company back ahead by around £3,000 to £4,000 vs sole trader.

2. Retaining profit in the company

If you do not need all the profit as cash this year, leave some in the company. The retained profit only attracts corporation tax (19% to 25%), not the additional dividend tax. Useful for funding business growth, buying assets, or building up a sale value for a later exit.

3. Business Asset Disposal Relief on exit

When you eventually sell a limited company that qualifies, BADR applies at 18% to the first £1m of capital gains. Sole traders sell goodwill differently and may not qualify for the same treatment. For owners building toward a sale, the limited company route has a long-tail advantage that does not show up in the year-by-year tax comparison.

Non-tax factors that often matter more

• Limited liability. A limited company is a separate legal entity. If something goes wrong (contract dispute, claim, debt), your personal assets are generally protected. Sole traders are personally liable for all business obligations. For trades with real liability risk (construction, professional advice, property letting), this often outweighs any tax difference.
• Client credibility. Larger clients, government contracts, and some industries (IT, engineering) increasingly require contractors to be limited. Some clients refuse to engage sole traders at all.
• Mortgage applications. Lenders treat limited company directors differently from sole traders. Some lenders accept retained company profit as personal income for affordability; others insist on dividend history only. Worth checking before incorporating if a mortgage is imminent.
• Pension contributions. Limited companies can make employer pension contributions that are fully deductible against corporation tax, with no cap based on earnings (just the £60,000 annual allowance). Sole traders contribute personally and need 'relevant earnings' to justify large contributions.
• Admin and cost. A limited company adds annual accounts, a Confirmation Statement, a CT600 corporation tax return, and a Self Assessment for the director. Typical extra cost: £600 to £1,500 a year. Sole traders file one Self Assessment.

The decision framework we use with clients

Five questions, in order:

1. Profit forecast for the next 3 years? Below £50,000 a year, sole trader almost always wins. Above £80,000 a year with no spouse / no retention, sole trader is competitive. Above that level with share-splitting or retention, limited usually wins.
2. Is there a non-earning spouse you could share with? If yes, limited company picks up an instant ~£3,000 to £6,000 tax advantage from share splitting.
3. Do you have real liability exposure? High- risk trades favour limited regardless of tax outcome.
4. Are you building toward a sale? Limited opens the BADR door at 18% on the first £1m of gain.
5. Can you accept the admin? Annual filings, director responsibilities, and bookkeeping discipline are non-negotiable for a limited company. If that feels burdensome at your stage, stay sole trader.

How to switch from sole trader to limited (and vice versa)

Sole trader to limited

The transition is called incorporation. You form a new limited company, transfer the existing business (goodwill, equipment, stock, customer relationships) into it, and start trading through the company. Tax considerations:

• Transfer of goodwill can trigger Capital Gains Tax for the sole trader
• Incorporation relief can defer the CGT if all qualifying conditions are met (transfer of whole business as a going concern, consideration wholly in shares)
• VAT registration moves with the business if turnover was already above £90,000
• Existing contracts may need to be novated to the company
• Insurance, bank accounts, and Direct Debits all need updating

Limited to sole trader

Less common but sometimes the right call. You stop drawing dividends, register as a sole trader, transfer the trade, and either keep the company dormant or strike it off. CGT can arise on the transfer of company assets to the owner. Pension scheme transfers and director loan account settlement need careful handling.