Sole Trader vs Limited Company: The Real Tax Effects Explained (And Why 2025 Is the Turning Point)

Introduction – Why More Sole Traders Are Looking at Limited Company Status

For many business owners, the question isn’t “Should I go limited?” anymore — it’s “When should I go limited?”

With tax thresholds frozen, National Insurance still taking a bigger bite than most realise, and MTDITSA on the horizon bringing six submissions a year instead of one, more business owners are recognising that incorporation isn’t just a paperwork change — it’s a strategic tax and growth decision.

Here’s the important truth:

You don’t automatically save tax when you go limited.

It depends on your profit level, how you withdraw money, and whether the business is structured correctly. That’s where talking to an accountant before you switch — not after — makes all the difference.

In this article, we’ll break down how sole traders and limited companies are taxed, with real-world examples at £25k, £45k, and £65k profit levels. We’ll also show how Hammond & Co helps business owners structure their company for maximum benefit.

How Sole Traders Are Taxed (The Current Reality)

As a sole trader, there is no separation between you and your business. Your profits are your personal income, and you pay:

Income Tax
Class 2 National Insurance
Class 4 National Insurance

Income Tax (2025/26)

Band	Rate
Up to £12,570	0%
£12,571 – £50,270	20%
£50,271 – £125,140	40%

National Insurance (2025/26)

Type	Rate
Class 2	£3.45 per week
Class 4	6% on profits £12,570–£50,270, 2% thereafter

Once profits reach roughly £30k–£35k, the combination of tax + NI starts to bite — even before hitting the higher-rate threshold.

How Limited Companies Are Taxed (Structured & Flexible)

Limited companies operate differently:

The company pays Corporation Tax on profits
Directors choose how to extract their income: salary, dividends, pensions, or retained profits

Corporation Tax Rates (2025/26)

Profit	CT Rate
£0–£50k	19%
£50k–£250k	Marginal/Blended rate
£250k+	25%

Directors typically pay:

Income Type	Personal Tax Treatment
Salary	PAYE (often set at NIC threshold)
Dividends	8.75% (basic) / 33.75% (higher) / 39.35% (additional)
Company pension contributions	Usually tax-deductible for the company

This is where structure matters — and where Hammond & Co helps clients maximise outcomes.

Tax Comparison – Profit £25,000

	Sole Trader	Limited Company
Profit	£25,000	£25,000
Income Tax	~£2,492	Salary low → minimal PAYE
NI	~£1,146	None personally (dividends)
Corporation Tax	n/a	~£2,500
Total Tax	~£3,638	~£2,500 (then dividends taxed)
Net Take-Home	Similar	Similar

Key point: At this level, incorporation isn’t necessarily a tax benefit, but liability protection and future planning make it worth considering.

Tax Comparison – Profit £45,000

	Sole Trader	Limited Company
Profit	£45,000	£45,000
Income Tax	~£6,492	Salary minimal
NI	~£2,046	Avoided
Corporation Tax	n/a	~£8,550 before dividends
Dividends Tax	n/a	~£2,400
Total Tax	~£8,538	~£6,000–£6,400

Saving: ~£2,000–£2,500 per year.

This is the first meaningful tipping point — exactly when Hammond & Co would advise considering incorporation.

Tax Comparison – Profit £65,000

	Sole Trader	Limited Company
Profit	£65,000	£65,000
Income Tax	~£14,292	Dividend mix keeps tax lower
NI	~£2,446	Avoided
Corporation Tax	n/a	~£12,350
Dividends Tax	n/a	~£4,000
Total Tax	~£16,738	~£13,500–£14,300

Saving: £2,500–£3,200+ per year.

At this profit level, a sole trader is already entering higher-rate tax. A structured limited company strategy can maintain much of the income at basic-rate levels.

Pensions – Supercharging Your Tax Savings

Employer pension contributions from a limited company:

	Sole Trader	Ltd Director
Contributions	From post-tax income	From company pre-tax profits
Tax benefit	None	Reduces Corporation Tax
Flexibility	Limited	Strategic planning tool

Example: a £10,000 company pension contribution reduces tax while preserving wealth for the director.

✅ Hammond & Co helps clients design pension and salary/dividend strategies for maximum benefit.

Income Splitting – A Key Advantage

Limited companies allow income to be split among shareholders (e.g., spouses), reducing overall tax liability:

Spouse with no other income can receive a dividend within the tax-free allowance
Dividends taxed at 8.75% (basic)
Saves thousands annually for family-run businesses

Retained Profits – Long-Term Wealth

Unlike a sole trader, a limited company can retain profits:

Pay lower corporation tax
Reinvest in growth
Extract later when personal tax rates are more efficient

Hammond & Co advises clients on timing of withdrawals and profit retention for optimal planning.

How MTDITSA Makes Sole Traders Less Efficient

From April 2026, all sole traders must:

Submit quarterly returns
Keep digital records
Submit End of Period Statements & Final Declarations

This increases administrative burden and makes the “stay a sole trader” argument less compelling. Limited companies already operate in a structured, digital environment.

Why Hammond & Co Makes the Difference

Going limited is easy. Doing it correctly and tax-efficiently is where most go wrong.

Our approach includes:

Director salary/dividend strategy → Minimises tax & NI
Shareholdings (including spouses) → Lower-rate extraction
Pension strategy → Diverts profit from HMRC
Digital bookkeeping → MTD-compliant
Quarterly reviews → Avoids year-end surprises
Tax forecasting → Prevents cash flow shocks
HMRC liaison → Complete peace of mind

The Real Picture: Before & After

Profit	Sole Trader Take-Home	Ltd Company Take-Home
£25,000	Similar	Similar
£45,000	Noticeably lower	£2k–£2.5k better
£65,000	Higher-rate tax bites	£2.5k–£3.2k+ better