Quick answer: most new businesses should start as a sole trader. It is cheap, simple, and early losses can reduce the tax on your other income. A limited company usually starts to make sense once the business is reliably profitable and you don't need to take all of the profit out, or when you need the protection of limited liability.
Choosing between a sole trader and a limited company is one of the first big decisions when you start working for yourself. There is no single right answer. It depends on how much you earn, whether you also have a job, and how you plan to grow. This guide explains the differences in plain English, using the rules for the 2026/27 tax year.
Starting out as a sole trader
A sole trader is simply you, trading in your own name. There is nothing to set up with Companies House, and the business's profit is treated as your personal income.
The £1,000 trading allowance. If your total income from self-employment (before expenses) is £1,000 or less in a tax year, you don't need to register or tell HMRC. Once it goes over £1,000, you must register for Self Assessment by 5 October after the end of that tax year, for example by 5 October 2027 for income in 2026/27.
Why it suits most people starting out:
- Less admin. One Self Assessment tax return a year, and no company accounts or Companies House filings*
- Lower costs. Accountancy fees are usually much lower than for a company
- Simple access to your money. The profit is yours, so you can take it out whenever you like
- Privacy. Your figures are not published anywhere
*One change to be aware of: Making Tax Digital for Income Tax now applies to sole traders and landlords with qualifying income over £50,000, falling to £30,000 from April 2027 and £20,000 from April 2028. That means digital records and quarterly updates to HMRC, which adds some admin as you grow.
The catch if you also have a job
As a sole trader, your business profit is added on top of everything else you earn, including any salary from a job. It is all taxed together, so your profit is taxed at your current or next marginal rate, not from zero.
Example: you earn a £45,000 salary and make £15,000 profit from a side business. (Profit means what is left after your business expenses, not your total sales.)
- Your salary has already used your £12,570 personal allowance and most of the 20% basic rate band
- The first £5,270 of profit is taxed at 20%, then the remaining £9,730 at 40%
- That is about £4,950 of income tax, plus about £150 of Class 4 National Insurance (6% on profit above £12,570)
- So roughly a third of your profit goes in tax
Watch out for the thresholds where tax rises sharply when your total income passes them:
- £60,000: the High Income Child Benefit Charge starts if you or your partner claim Child Benefit
- £100,000: you start losing your personal allowance, which works out at an effective rate of 60% on income between £100,000 and £125,140
If your side business is pushing you into these bands, that is often the point where a limited company is worth a look.
The upside: early losses can cut your tax bill
The same rule that taxes your profit on top of your salary works in your favour when the business makes a loss.
Most new businesses make a loss in the first year or two, because of set-up costs, equipment and marketing. As a sole trader, you can usually set that loss against your other income in the same tax year or the year before. That includes your salary. HMRC then refunds some of the tax you have already paid through PAYE.
There is also a special relief for new businesses: a loss in any of your first four tax years of trading can be carried back against your other income for the three previous tax years, earliest first.
Example: you earn a £45,000 salary and your new business makes a £8,000 loss in its first year. Claiming the loss against your salary could get you a refund of about £1,600 (20% of £8,000), or more if you are a higher-rate taxpayer.
The refund isn't the whole £8,000. The loss reduces your taxable income by £8,000, so you get back the tax you paid on that slice of your salary: £8,000 at 20% is £1,600. Any National Insurance you paid on your salary isn't refunded.
A limited company can't do this. Its losses stay inside the company and can only be used against the company's own future profits.
A sensible approach for many people is to start as a sole trader, use the early losses against your employment income, and move to a limited company once the business is reliably profitable.
A few rules apply: the business must be run on a commercial basis with a view to profit. The relief is capped at £50,000 or 25% of your income, whichever is higher. And if you spend fewer than 10 hours a week on the business, the cap is £25,000.
Why a limited company can be worth it
Limited liability. A company is a separate legal person. If the business runs into debt or is sued, your personal assets, such as your home and savings, are usually protected. (Personal guarantees, for example on a bank loan or a lease, can override this.)
Lower tax on profit you leave in the business. Companies pay corporation tax at 19% on profits up to £50,000, rising to 25% on profits over £250,000. You only pay personal tax on what you take out, so you can keep money in the company to fund growth, or take it in a year when your other income is lower.
More ways to take your money out tax-efficiently:
- A small salary, usually set around the personal allowance (£12,570), which also counts towards your State Pension
- Dividends from profits after corporation tax. The first £500 is tax-free for everyone, whatever your tax band, then 10.75% in the basic rate band and 35.75% in the higher rate band, with no National Insurance
- Repaying your director's loan. Money you put into the company can be paid back to you tax-free. See our guide to the director's loan account
- Employer pension contributions, which are normally a deductible expense for the company and free of National Insurance
- Small tax-free extras, such as trivial benefits of up to £50 each (capped at £300 a year for directors), and 55p a mile for the first 10,000 business miles in your own car (25p after that)
Credibility. "Ltd" after your name can reassure larger clients and suppliers. Some businesses will only work with limited companies, and it can make borrowing or bringing in investors easier.
Easier to grow and pass on. You can add shareholders, bring in a partner, or sell the business more easily than as a sole trader.
The downsides of a company
More admin to keep on top of. As a director you are responsible for:
- Annual accounts filed with Companies House, and a company tax return (CT600) to HMRC
- A confirmation statement every year (£50 filing fee)
- Running a payroll if you pay yourself a salary, with monthly reports to HMRC
- Your own Self Assessment return as well, if you take dividends above your allowances
- Keeping company money separate from your own, with a business bank account and proper records
Higher accountancy fees. Because there is more to prepare and file, fees are usually noticeably higher than for a sole trader. It costs £100 to set up a company online at Companies House, and every director now has to verify their identity. Meridian Accountants Limited is an Authorised Corporate Service Provider (ACSP), so we can complete identity verification and company set-up for our clients.
Your accounts are public. Anyone can look up your company's accounts, directors and shareholders on Companies House. That said, small companies can file shortened accounts, usually just a balance sheet and a few notes, with no profit and loss account, so how much you earn isn't shown.
The money belongs to the company, not you. You can't simply transfer cash to yourself. It has to come out as salary, dividends or a director's loan, each with its own tax rules. An overdrawn director's loan account can cost the company extra tax: see our director's loan account guide.
The Employment Allowance trap for one-person companies. You can employ yourself through the company and pay yourself a salary. But the Employment Allowance, which knocks up to £10,500 a year off employer National Insurance, isn't available if you are the only employee and also a director. So a one-person company pays employer National Insurance at 15% on salary above £5,000 a year. This is why directors in single-person companies often keep their salary low and take the rest as dividends.
At a glance
| Sole trader | Limited company | |
|---|---|---|
| Set-up | Register for Self Assessment once income is over £1,000 | Register at Companies House (£100 online) and verify your identity |
| Personal liability | Unlimited: you are the business | Limited, except for personal guarantees |
| Tax on profit | Income tax 20% / 40% / 45% plus Class 4 NI 6% / 2% | Corporation tax 19% to 25%, then tax on what you take out |
| Losses | Can be set against your salary and other income, with refunds | Stay in the company for its future profits |
| Taking money out | All profit is yours | Salary, dividends, director's loan repayments, pension |
| Admin | One tax return a year (plus MTD quarterly updates above the threshold) | Accounts, company tax return, confirmation statement, payroll, personal tax return |
| Accountancy fees | Lower | Higher |
| Privacy | Figures are private | Accounts, directors and shareholders are public |
| Credibility | Fine for most customers | Often preferred by larger clients |
How the tax compares in 2026/27
Here is the total tax on a one-person business at different profit levels, assuming no other income. Profit here means what is left after business expenses, not your total sales.
| Profit (after expenses) | Sole trader | Company, all profit taken out | Company, take home about £46,000 and leave the rest in |
|---|---|---|---|
| £30,000 | £4,532 | £5,597 | n/a |
| £50,000 | £9,732 | £11,138 | n/a |
| £80,000 | £22,289 | £24,235 | £18,953 (£14,776 kept in the company) |
| £100,000 | £30,689 | £34,790 | £24,253 (£29,476 kept in the company) |
The company figures assume a £12,570 salary with the rest as dividends, and no Employment Allowance. The figures are for England, Wales and Northern Ireland, and leave out accountancy fees and pension contributions.
What this shows: since dividend tax went up in April 2026, a one-person company that pays out all of its profit usually pays slightly more tax than a sole trader. The real saving comes when you don't need all the profit personally. Profit left in the company is taxed at 19% to 25% instead of 40%, and you can take it out later, in a lower-income year, or as pension contributions. So the decision is about more than tax rates: how much you need to live on, your plans for the business, and how much the protection of limited liability matters to you.
Signs you have outgrown being a sole trader
- Profits are consistently high and you don't need all of them to live on
- Business profit is pushing your total income into the 40% band, past £100,000, or into the Child Benefit charge
- You are taking on bigger contracts, staff, premises or borrowing, so personal liability is a real risk
- Clients ask to work with a limited company
- You want to bring in a partner, investor or family member as a shareholder
- You are planning to sell the business one day
How to switch from sole trader to limited company
- Set up the company at Companies House and open a business bank account.
- Transfer the business. That covers equipment, stock, contracts, customers and goodwill. Done properly, reliefs are usually available so that no capital gains tax is due.
- Tell HMRC that you have stopped trading as a sole trader. You will file one final Self Assessment return for the business after the end of the tax year in which your sole trader income stops. For example, if you stop in December 2026, your final return covers 2026/27 and is filed after 5 April 2027 (due by 31 January 2028).
- Update VAT, payroll, insurance, contracts and your invoices to the company's name and details.
- Carry forward unused losses. If your sole trader business had losses you haven't used, they can often be set against income you later receive from the company, such as salary or dividends, if the business was transferred in exchange for shares.
Timing matters, especially around the end of the tax year, so it is worth getting advice before you switch.
Frequently asked questions
Do I need to register as a sole trader if I earn under £1,000?
No. If your total self-employed income before expenses is £1,000 or less in a tax year, the trading allowance covers it and you don't need to register or tell HMRC.
When do I need to register as a sole trader?
By 5 October after the end of the tax year in which your self-employed income went over £1,000. For income in the 2026/27 tax year, that is 5 October 2027.
Can I be employed and a sole trader at the same time?
Yes. Your business profit is added to your salary and taxed together, so it is taxed at your highest rate. Any early losses can be set against your salary to get a tax refund.
Is a limited company always more tax-efficient?
No. In 2026/27, a one-person company that takes out all of its profit often pays slightly more tax than a sole trader. The savings come from leaving profit in the company, pension contributions and planning when you take income.
Can I claim the Employment Allowance as a one-person limited company?
No. If you are the only employee and also a director, the company can't claim it. It becomes available once you employ someone else, other than another director, on a salary above £5,000 a year.
Can I switch from sole trader to limited company later?
Yes. Many people start as a sole trader and incorporate once the business is established. Reliefs are usually available so that transferring the business doesn't trigger a tax bill.
In short
- Start as a sole trader if you are testing an idea, profits are modest, or you expect early losses you can set against a salary.
- Think about a limited company once profits are reliable and you don't need them all, or when limited liability and credibility matter.
- The right answer depends on your whole financial picture, not just the business.
Not sure which is right for you? Meridian Accountants, Chartered Accountants in Southampton, working with individuals and businesses across Southampton, Romsey, Winchester, the New Forest, Totton and surrounding areas, can run the numbers on your own figures, and help you register as a sole trader or set up and run your limited company. Get in touch to book a call.
This article is general information based on the rules for the 2026/27 tax year in England, Wales and Northern Ireland. It is not advice on your specific circumstances. Please speak to an accountant before acting.