Is it more cost-effective to operate as a sole proprietor?
In the world of small business, making the right choice between operating as a sole trader or incorporating as a limited company can have significant tax implications. Here's a breakdown of the key factors to consider in the 2025-26 tax year.
For sole traders, the tax burden comes in the form of Income Tax on business profits, with rates of 20%, 40%, or 45% depending on the tax bracket. Additionally, 6% Class 4 National Insurance contributions are payable above the Personal Allowance of £12,570. This means that on a profit of £50,000, a sole trader would pay approximately £7,486 in Income Tax and £2,246 in NICs, leaving a take-home pay of about £40,268.
On the other hand, limited companies pay Corporation Tax on profits, currently at a rate of 25%. Owners typically extract income via a combination of salary and dividends, which can offer tax efficiency. However, the owner must also pay income tax or National Insurance on earnings, or dividend tax rates on dividends.
The idea of a company offering greater tax efficiency has been ingrained among entrepreneurs, but data from the Office for National Statistics suggests a counterintuitive trend. Tax changes in recent years have made it less attractive to run a business through a company structure. Increases in corporation tax and dividend tax rates, as well as reductions in the tax-free dividend allowance, have made it more likely that operating through a company will result in a higher tax bill for many small-business owners.
Small-business experts are concerned that the impact of these changes has been poorly understood. They advise that individual owners should review their business's tax position to ensure they're not putting themselves at a disadvantage. It makes sense to consult an accountant to analyze the figures under both structures for a better understanding.
One advantage of a company structure is the limited liability protection it offers for owners from personal liability for losses or liabilities incurred by the business. This can provide peace of mind for many business owners.
However, for new business founders, incorporation is not always the right route to go down. Sole traders face fewer administrative requirements, but they have unlimited personal liability. Limited companies must comply with Companies House filings and annual accounts, but they gain legal protection and potentially beneficial tax treatment.
In summary, the choice between sole trader and limited company status depends on several factors, including income level, administrative capacity, liability concerns, and planned remuneration structure. It's crucial for small-business owners to consider all aspects carefully and seek professional advice to make an informed decision.
[1] HM Revenue & Customs (2025). Employer National Insurance Contributions. [Online] Available: https://www.gov.uk/employers-national-insurance-rates
[2] Small Business Charter (2025). Incorporation vs Sole Trader: Which is Best for Your Business? [Online] Available: https://smallbusinesscharter.org/advice/incorporation-vs-sole-trader-which-is-best-for-your-business/
[3] HM Revenue & Customs (2025). Self Assessment. [Online] Available: https://www.gov.uk/self-assessment-tax-returns/overview
[4] Office for National Statistics (2025). Business population estimates. [Online] Available: https://www.ons.gov.uk/businessindustryandtrade/business/businesspopulationestimates/bulletins/businesspopulationestimatesforukenglandandregions/january2025
[5] HM Treasury (2025). Spring Statement 2025. [Online] Available: https://www.gov.uk/government/publications/spring-statement-2025/spring-statement-2025-documents
- In the realm of finance, limited companies, compared to sole traders, offer the potential for tax efficiency, as they can pay Corporation Tax at a rate of 25%, and owners can extract income through a combination of salary and dividends.
- However, ongoing changes in tax regulations, such as increases in corporation tax and dividend tax rates, as well as reductions in the tax-free dividend allowance, may result in a higher tax bill for small-business owners operating through a company structure, making it essential for them to review their tax position and seek professional advice to determine the most advantageous business structure.
