How Limited Companies Are Taxed in 2026
A limited company pays Corporation Tax on its taxable profits. The rates for 2026/27 remain as follows:
- Small profits rate: 19% on profits up to £50,000
- Main rate: 25% on profits over £250,000
- Marginal Relief: A tapered rate applies to profits between £50,001 and £250,000
For most small companies with profits comfortably below £50,000, the effective Corporation Tax rate remains 19%. You can find the current rates on GOV.UK.
As a director, you are then taxed personally on any money you take out of the company. The most common approach for owner-managed companies is to take a low salary up to the National Insurance threshold and draw the remainder as dividends. This can result in a meaningfully lower overall tax burden compared to operating as a sole trader, though the gap depends heavily on profit level, personal circumstances, and how much you actually need to withdraw from the company.
Salary and Dividends: The Director Extraction Strategy
Most limited company directors take a salary at or around the Personal Allowance of £12,570 per year, using up their tax-free band and keeping income tax to zero on that element. However, because the employer National Insurance secondary threshold is now £5,000, the company will pay employer NI at 15% on the portion of salary above that level. On a £12,570 salary, that means employer NI of approximately £1,136 per year. The Employment Allowance can offset this cost by up to £10,500 per year, though it is not available to sole director companies where the director is the only employee. Where the Employment Allowance is not available, some directors choose to take a salary of £5,000 or below, eliminating employer NI entirely, but losing the benefit of the Personal Allowance on that income. The right salary level depends on individual circumstances and should be reviewed with an accountant.
Dividends are paid from after-tax profits and attract a separate tax treatment. The Dividend Allowance for 2026/27 remains at £500. Beyond that, dividends are taxed at the following rates, which increased from 6 April 2026 as confirmed at the Autumn Budget 2025:
- Basic rate: 10.75% (up from 8.75% in 2025/26) on dividend income within the basic rate band
- Higher rate: 35.75% (up from 33.75% in 2025/26) on dividend income within the higher rate band
- Additional rate: 39.35% (unchanged) on dividend income above £125,140
The increase in dividend tax rates from April 2026 has reduced, but not eliminated, the tax advantage of the limited company route for many directors. Dividends still do not attract National Insurance, which remains a significant part of the overall saving compared to sole trader profits, particularly at higher income levels.
Retaining Profit in the Company
One of the genuine advantages of a limited company that sole trader comparisons often overlook is the ability to retain profit inside the company rather than drawing it all out. Retained profit sits in the company taxed at 19% rather than flowing immediately through to you as personal income at 40% or 45%. This can be particularly valuable if your personal income needs are already met and you want to build capital inside the business.
When Does Incorporation Start to Make Financial Sense?
This is the question most business owners want answered directly, and the honest answer is that it depends on a number of variables. However, some broad guidance is possible based on profit levels.
- Under £30,000 profit: Sole trader is almost always the better option. Corporation Tax savings at this level are minimal and the additional accountancy and compliance costs of running a limited company will typically outweigh any benefit.
- £30,000 to £50,000 profit: The case for incorporation is mixed. A limited company may offer some tax saving if you can retain profit in the company or split dividends with a spouse who is a shareholder, but the administrative overhead and additional accountancy fees mean sole trader status remains viable and often preferable.
- Above £50,000 profit: The tax case for a limited company becomes increasingly clear. At £60,000 profit, a limited company structure can save a higher rate taxpayer a meaningful sum compared to sole trader status, primarily through avoiding National Insurance on dividend income and the lower Corporation Tax rate on retained profits.
- Above £80,000 profit: The tax saving from incorporating and extracting via salary and dividends, combined with the option to make employer pension contributions through the company, can be substantial. At this level, the financial case for a limited company is typically strong.
These are generalisations. The right answer for you will depend on whether you have other income, whether you have a spouse or civil partner who can also be a shareholder, whether you need to withdraw all profits personally each year, and a range of other factors. An accountant who understands your full picture will give you a far more precise answer than any general guide can.
Making Tax Digital for Income Tax: A Significant Change for Sole Traders in 2026
One development that makes 2026 a particularly important year for sole traders to review their position is the introduction of Making Tax Digital for Income Tax (MTD for ITSA). This represents a significant change to how sole traders and landlords report their income to HMRC.
From 6 April 2026, sole traders and landlords with qualifying gross income above £50,000 must use MTD-compatible software to keep digital records and submit quarterly updates to HMRC. The qualifying income threshold is based on your combined gross turnover from self-employment and property income as reported on your 2024/25 Self Assessment return. It is assessed on gross income before expenses, not profit.
The rollout continues in subsequent years:
- April 2027: Mandatory for those with qualifying income above £30,000
- April 2028: Mandatory for those with qualifying income above £20,000
Limited companies are not subject to MTD for Income Tax in the same way. They already operate through company accounts and Corporation Tax reporting rather than the sole trader Self Assessment process. For some higher-earning sole traders, the additional reporting burden of MTD is one factor prompting them to consider whether incorporation might now make more practical sense alongside any potential tax benefit.
More detail on MTD for Income Tax is available on GOV.UK.
Legal Liability: Understanding the Difference
As a sole trader, you are personally responsible for all business debts. If your business fails and owes money to suppliers, HMRC, or anyone else, your personal assets, including your home, are at risk. There is no legal separation between you and your business.
A limited company provides what is known as limited liability. If the company runs into financial difficulty, your personal exposure is generally limited to the value of your shares and any personal guarantees you have signed. This protection is not absolute. Directors who trade while knowingly insolvent, or who make fraudulent decisions, can be held personally liable. But in normal circumstances, the separation between the company and its directors provides meaningful protection.
For businesses operating in sectors with significant professional risk, or those taking on large contracts or borrowing, limited liability can be a compelling reason to incorporate even before the tax case becomes clear-cut.
Administration and Compliance: What Each Structure Involves
Sole Trader Requirements
- Register as self-employed with HMRC by 5 October following the end of the first tax year in which you trade
- Keep records of income and expenses
- File an annual Self Assessment tax return by 31 January (online)
- Pay any tax and National Insurance due by 31 January, with Payments on Account in January and July if applicable
- Register for VAT if your taxable turnover exceeds £90,000
Limited Company Requirements
- Incorporate the company with Companies House (the digital incorporation fee is £100 from 1 February 2026, with an annual Confirmation Statement fee of £50)
- File annual statutory accounts with Companies House
- File a Confirmation Statement with Companies House each year
- File a Corporation Tax return with HMRC within 12 months of the company’s accounting year end
- Pay Corporation Tax within nine months and one day of the accounting year end
- Run a payroll if paying a salary, including Real Time Information (RTI) submissions to HMRC
- Directors must file personal Self Assessment returns
- Register for VAT if taxable turnover exceeds £90,000
The administrative overhead of a limited company is substantially greater than that of a sole trader. This is reflected in accountancy fees. You should expect to pay more for a limited company accountant than for sole trader accounts and Self Assessment, sometimes significantly more depending on the complexity of your affairs. That additional cost is a genuine factor in the decision, particularly at lower profit levels.
Credibility and Commercial Considerations
Beyond the numbers, there are practical commercial reasons why some business owners choose to incorporate even before the tax case is clear-cut.
Some larger businesses and public sector organisations have a preference, or in some cases a formal policy, for contracting only with limited companies. If you operate as a contractor or consultant and your target clients fall into this category, incorporation may be a commercial necessity rather than a purely financial choice.
A limited company can also present a more professional image, particularly when competing for larger contracts or seeking investment. The fact that your accounts are publicly available can work both ways, but for businesses wanting to demonstrate longevity and financial credibility to clients, having Companies House registration and a registered company name can be an advantage.
IR35: A Key Consideration for Contractors
If you work through a limited company providing services to clients, particularly larger organisations, IR35 is a risk you cannot ignore. IR35 is the off-payroll working legislation designed to tackle what HMRC calls disguised employment, where an individual works through a company but the reality of the arrangement is more like employment.
If your engagement falls inside IR35, most of the tax advantages of operating through a limited company are removed. You will pay deemed employment income tax and National Insurance on most of the income from that engagement, leaving you with the administrative burden of a limited company without the tax benefit.
Since April 2021, responsibility for assessing IR35 status on most engagements has rested with the client organisation rather than the contractor. If you provide services through a limited company to medium or large private sector businesses, or to any public sector body, your IR35 status will generally be determined by your client. If your work falls outside IR35, a limited company can remain very tax-efficient. If it consistently falls inside IR35, the case for incorporation weakens considerably.
More information on IR35 is available on GOV.UK.
Should You Switch from Sole Trader to Limited Company?
If you are already trading as a sole trader and wondering whether the time is right to incorporate, the following factors tend to signal that the conversation is worth having with your accountant:
- Your profits are consistently above £40,000 to £50,000 per year
- You do not need to withdraw all of your profit as personal income each year
- You are entering into contracts where limited liability would be a genuine benefit
- Clients or prospects are asking you to operate through a limited company
- You want to bring in other shareholders or business partners
- Your business carries significant professional or commercial risk
- You are approaching the MTD for Income Tax threshold and want to consider your options
Incorporation is not reversible without tax implications, so it is not a decision to take lightly or make purely on the basis of general guidance. The transition process also requires careful planning, particularly around any assets or contracts being transferred from sole trader to company.
Final Thoughts on Sole Trader Vs Limited Company
The decision between operating as a sole trader or through a limited company is not simply about which structure pays less tax. It involves weighing legal protection, administrative burden, commercial relationships, personal financial planning, and the stage your business has reached.
For most business owners at lower profit levels, the simplicity of sole trader status makes practical and financial sense. As profits grow, the tax efficiency of a limited company becomes more compelling, particularly where you can retain profit in the company, extract via a combination of salary and dividends, or make use of employer pension contributions. The introduction of MTD for Income Tax from April 2026 adds another dimension for sole traders earning above £50,000, making 2026 a natural point to review your structure if you have not done so recently.
Neither structure is automatically superior. The right answer depends on your specific circumstances, your plans for the business, and a realistic view of the costs and obligations involved.
If you would like to understand which structure is right for your business, the team at Accounting Wise is here to help. We work with sole traders, limited company directors, and business owners at every stage, providing fixed-price accounting packages tailored to your needs. Book a free call back today and let us help you make the right decision for your business in 2026.
