Sole trader vs limited company: the tax difference explained

Sole trader: how the tax actually works

You and the business are the same legal person. There is no distinction between “business money” and “your money” for tax purposes — every pound of trading profit is yours, and is taxed accordingly (GOV.UK; GOV.UK — self-employed NI).

• Income Tax at 20% (basic), 40% (higher) and 45% (additional) on profit above the £12,570 personal allowance.
• Class 4 National Insurance at 6% on profits above the threshold. Class 2 NI has been abolished for sole traders above the small-profits threshold.
• Taxed on all profit, every year.There is no “leave it in the business” option — profit is yours and taxed whether drawn or not.
• One return. The whole thing goes through a single Self Assessment SA100, with the trading pages attached. No separate company tax return.

The simplicity is real and it is the sole trader’s biggest practical advantage. The cost is that there is no flexibility about when profit is taxed — a strong year is taxed in full at your marginal rate, even if you wanted to leave some of it inside the business for next year.

Limited company: how the tax actually works

A limited company is a separate legal entity. The company is taxed first; you are taxed second, only on what you extract (GOV.UK — Corporation Tax; GOV.UK — Tax on dividends).

• Corporation Tax on company profit: 19% up to £50,000, marginal relief between £50,000 and £250,000 (an effective rate of about 26.5% on profit in that band), 25% above £250,000.
• Then dividend tax on extraction: 10.75% (basic), 35.75% (higher), 39.35% (additional), above the £500 dividend allowance — and no NI on dividends.
• A small salary (commonly £5,000 or £12,570) plus dividends is the usual mix — see the Salary vs Dividends guide.
• You choose when to extract. Profit can stay in the company, taxed only at Corporation Tax, until you draw it in a later (potentially lower-income) year.

The cost is administrative. The company files annual accounts at Companies House, a CT600 Corporation Tax return, payroll for any salary, and dividend paperwork; the director files their own Self Assessment for personal income. That admin is real money — typically several hundred to a few thousand pounds a year of accountancy time — and is the reason the tax saving has to be meaningful before incorporating makes sense at low profits.

The key conceptual difference: profit vs extraction

A sole trader is taxed on profit. A company director is taxed on extraction. That single sentence is the whole structural difference, and it drives every other planning choice in this cluster.

For a sole trader, the tax bill is decided by how much profit the business makes — you cannot defer it, smooth it, or move it into a future year. For a limited company, the tax bill has two parts: a Corporation Tax bill driven by the company’s profit, and a personal dividend tax bill driven by how much (and when) the director takes money out. That timing flexibility is the company’s real structural advantage — and it is why the comparison is never just “which has lower headline rates.”

A worked example: £50,000 of profit, full extraction

Take a business making £50,000 of profit in 2026/27. The owner needs to take all of it as personal income — full extraction, no retention, no pension contributions, no spousal split. How do the two structures compare on a like-for-like basis?

At £50,000 of profit on full extraction, the sole trader saves roughly £2,717 a year at 2026/27 rates. The limited company would only overtake at this profit level with the extras the headline comparison ignores — retained profit at 19%, an employer pension contribution, a spousal dividend split, or a higher-rate marginal benefit elsewhere. That is the whole point of the cluster: the simple full-extraction comparison no longer favours the company at low-to-middling profits, which is exactly what most online content still gets wrong (GOV.UK).

Figures are rounded illustrative calculations using 2026/27 rates and thresholds, ignoring employer NI on the small director’s salary (covered separately in the optimal-salary spoke) and any Employment Allowance treatment. Your own numbers will differ — run them on the Salary vs Dividend optimiser or with an accountant.

Where to go next

• At what profit should I become a limited company? — the 2026/27 crossover bands and the costs that push the answer higher than people expect.
• Has the tax advantage of a limited company shrunk? — why the CT rise and the April 2026 dividend increase changed the picture.
• Salary vs Dividends 2026/27 — how directors actually extract income from a company tax-efficiently.
• The Self Assessment guide — the annual return both sole traders and directors generally file.
• Making Tax Digital for Income Tax — the quarterly reporting regime now affecting sole traders and landlords over £50,000.