Sole trader or limited company? A 2026/27 guide
Starting a business is exciting, but one of the first decisions you'll need to make is whether to operate as a sole trader or through a limited company.
It's a question we hear regularly at SOS Accounting, and the answer isn't always straightforward. The right choice depends on your income, future plans, appetite for administration and how much personal financial protection you want.
While tax is often a key factor, it's only one piece of the puzzle. Your business structure can affect how you pay yourself, the records you need to keep, your legal responsibilities and even how attractive your business appears to customers and lenders.
In this blog, we'll explain the differences in terms you can understand and highlight some key tax considerations for the 2026/27 tax year.
What is a sole trader?
A sole trader is the simplest way to run a business.
You and your business are legally the same entity, meaning you keep all profits after tax, but you're also personally responsible for any debts the business owes.
Many freelancers, consultants, tradespeople and small business owners start out as sole traders because it's quick to set up and involves less administration.
Benefits of being a sole trader
- Simple and inexpensive to set up
- Less paperwork and fewer filing requirements
- Complete control over business decisions
- Easy access to business profits
- Lower accountancy and compliance costs
Drawbacks of being a sole trader
- Personal responsibility for business debts
- Fewer tax planning opportunities
- Harder to separate personal and business finances
- Can appear less established to some customers and lenders
What is a limited company?
A limited company is a separate legal entity from the people who own it.
The company earns the income and pays the expenses. As a director and shareholder, you can then pay yourself through a combination of salary, dividends and pension contributions.
Because the company is legally separate, your personal assets are generally protected if the business experiences financial difficulties.
Benefits of a limited company
- Limited liability protection
- More opportunities for tax planning
- Greater flexibility around when profits are extracted
- Often viewed as more established and professional
- Easier to bring in shareholders or investors
Drawbacks of a limited company
- More administration and compliance requirements
- Additional filing obligations with HMRC and Companies House
- Separate business bank account recommended
- Company money belongs to the company, not the director
More of a quick summary person? Here are the the key differences at a glance
Ownership of profits
Sole trader
The business profits belong to you personally. You can withdraw money whenever you want without any formal process.
Limited company
The profits belong to the company. To access the money, you normally take a salary, dividends or pension contributions.
Liability
Sole trader
You are personally responsible for business debts and legal obligations. Your personal assets could be at risk if the business encounters financial difficulties.
Limited company
The company is a separate legal entity. In most situations, your personal liability is limited, helping to protect your personal assets.
Administration
Sole trader
Generally requires less paperwork and fewer filing obligations.
Limited company
Requires annual accounts, Corporation Tax returns, confirmation statements and ongoing company record keeping.
How business expenses work
Understanding allowable expenses is important because claiming the right costs can reduce your tax bill.
Sole traders
Sole traders can claim expenses that are wholly and exclusively for business purposes.
Where an expense has both business and personal use, you can usually claim the business proportion.
Examples include:
- Mobile phone bills
- Home office costs
- Broadband
- Vehicle expenses
- Utility bills
For example, if you use your phone 60% for business and 40% personally, you can generally claim 60% of the cost.
Limited companies
The rules are stricter for company directors.
If the company pays for something that has personal use, it may create a Benefit in Kind.
A Benefit in Kind is a non-cash perk provided by the company, such as private medical insurance or personal use of company assets. These benefits often create additional tax and reporting obligations.
Making Tax Digital: what sole traders need to know
One of the biggest changes affecting sole traders is Making Tax Digital for Income Tax (MTD for IT).
This is HMRC's move towards digital record-keeping and more frequent reporting.
Who will be affected?
From April 2026:
- Sole traders and landlords with qualifying income above £50,000
From April 2027:
- Threshold reduces to £30,000
From April 2028:
- Threshold reduces to £20,000
Qualifying income refers to your gross income from self-employment and property before expenses are deducted. EG the amount you get paid.
Under MTD for IT, affected taxpayers will need to:
- Keep digital records
- Submit quarterly updates
- Submit an end-of-period statement
- Complete a final declaration
Many business owners underestimate the extra administration involved, so it's worth preparing early.
The £100,000 income trap
One of the most important tax thresholds in the UK is £100,000.
Once your adjusted net income exceeds £100,000, your Personal Allowance starts to reduce.
For every £2 earned above £100,000, you lose £1 of Personal Allowance.
By the time income reaches £125,140, the allowance has been completely removed.
This creates an effective tax rate of around 60% on income within this range because you're paying higher-rate tax while simultaneously losing tax-free allowance.
This affects both sole traders and company directors.
Planning ahead can help reduce the impact, particularly through pension contributions and other legitimate tax planning strategies.
When does a limited company become more tax efficient?
Unfortunately this isn't an easy answer as there is no single profit level where everyone should incorporate.
The answer depends on:
- Your total income
- How much money you need to live on
- Whether you have other income sources
- Pension planning goals
- Family circumstances
- Future growth plans
In general, many business owners start reviewing incorporation once profits consistently move beyond £50,000 to £60,000 per year.
This is because a limited company can provide more flexibility over:
- Timing of income withdrawals
- Dividend planning
- Pension contributions
- Managing tax bands
How Corporation Tax works for limited companies
If you run a limited company, the company pays Corporation Tax on its profits before you take money out personally.
Corporation Tax is different from Income Tax. Instead of being charged on what you earn personally, it's charged on the profits made by the company.
For the 2026/27 tax year:
- Companies with profits up to £50,000 generally pay Corporation Tax at 19%.
- Companies with profits above £250,000 generally pay Corporation Tax at 25%.
- Companies with profits between these amounts may qualify for Marginal Relief, which gradually increases the effective tax rate between the two thresholds.
Why this matters
Many business owners assume that a limited company automatically means paying less tax. In reality, it's more complicated than that.
After the company pays Corporation Tax, you'll usually pay further tax if you take profits out as dividends. This means it's important to look at the overall tax position rather than focusing on Corporation Tax alone.
One advantage many directors overlook
Unlike sole traders, limited company directors don't have to withdraw all profits immediately.
Any profits left in the company can be used to:
- Invest in equipment or stock
- Build a cash reserve
- Fund future growth
- Make pension contributions
- Draw income in a later tax year
This flexibility can make a significant difference to long-term tax planning.
When a limited company can become more attractive
As profits grow, a limited company may offer more opportunities to manage tax efficiently through:
- Salary and dividend planning
- Employer pension contributions
- Timing of profit withdrawals
- Retaining profits within the business
However, these benefits need to be balanced against the additional administration and compliance requirements that come with running a company.
The bottom line
Choosing a limited company purely because of Corporation Tax rates can be misleading. The best structure depends on your profit levels, personal income needs and future business plans.
A personalised comparison using your own figures will usually provide a much clearer answer than relying on generic tax examples.
Why directors have more flexibility
One advantage of a limited company is that profits do not have to be withdrawn immediately.
A sole trader pays tax on profits when they are earned, regardless of whether the money is taken out of the business.
A company director can choose to:
- Take profits now
- Leave funds in the company
- Invest in growth
- Build cash reserves
- Extract profits in future years
This flexibility can be valuable for business owners whose income varies from year to year.
Pension contributions: an often-overlooked tax planning tool
Pensions can play a major role in reducing tax while building long-term wealth.
Sole traders
Pension contributions are made personally.
You receive Income Tax relief based on your tax rate, but National Insurance has already been paid on the profits.
Limited company directors
Employer pension contributions can be made directly by the company.
This often creates a double benefit:
- The contribution can reduce the company's Corporation Tax bill.
- No Income Tax, dividend tax or National Insurance is payable on the contribution itself.
For many directors, pension contributions are one of the most tax-efficient ways to extract value from a business.
The standard annual pension allowance remains £60,000, although higher earners may be subject to different rules.
Family tax planning considerations
There are a number of family-related tax thresholds worth monitoring.
Marriage Allowance
Where one spouse or civil partner has unused Personal Allowance, they may be able to transfer part of it to their partner, subject to eligibility.
Child Benefit
The High Income Child Benefit Charge applies where either partner has adjusted net income above £60,000.
The charge increases gradually and can result in some or all Child Benefit being repaid through Self Assessment.
Protecting your personal assets
Tax often gets most of the attention, but legal protection can be just as important.
As a sole trader, you are personally responsible for business debts and obligations.
If the business cannot pay its debts, creditors may be able to pursue your personal assets.
With a limited company, the business is generally treated as a separate legal entity.
In most situations, your personal liability is limited, giving you an additional layer of protection when taking on larger contracts, borrowing money or expanding the business.
So, should you be a sole trader or a limited company?
There is no universal answer.
A sole trader structure may suit you if:
- You're just starting out
- Your profits are relatively modest
- You want minimal administration
- Simplicity is your priority
A limited company may be worth considering if:
- Profits are growing consistently
- You want greater tax planning opportunities
- You wish to build retained profits
- You want additional legal protection
- You plan to expand the business
The right choice depends on your circumstances, not just your tax bill.
Frequently asked questions
Is it better to be a sole trader or a limited company?
Neither structure is automatically better. The best option depends on your profits, future plans, appetite for administration and need for liability protection.
Do limited companies pay less tax?
Not always. While limited companies can offer more tax planning opportunities, the overall position depends on how profits are extracted and your personal circumstances.
Can I change from sole trader to limited company?
Yes. Many business owners start as sole traders and later incorporate as their business grows.
At what profit level should I become a limited company?
There is no fixed threshold, but many businesses begin reviewing incorporation when profits consistently exceed £50,000 to £60,000 per year.
Does Making Tax Digital affect limited company directors?
Not usually because of their company income. However, directors with qualifying property income or sole trader income may still be caught by MTD for Income Tax.
Final thoughts
Choosing between a sole trader business and a limited company isn't just about paying less tax. It's about balancing flexibility, protection, administration and future growth.
As your income increases, key thresholds such as £50,000, £60,000 and £100,000 can have a significant impact on your finances, making regular reviews increasingly important.
If you're unsure which structure is right for your business, speaking to an accountant before making a decision can save you both time and money in the long run.