From Sole Trader to Limited Company: The Actual 'Right Time' to Incorporate. Incorporation timing for tax efficiency.

When is the best time to incorporate?

You've heard it before. "Once you hit £50,000 profit, you need to incorporate." Or maybe it was £40,000. Or £60,000. Every business owner seems to have their magic number, and they're all absolutely certain about it.

Here's what makes me uncomfortable about this advice: for most single-person businesses, staying as a sole trader is actually more tax-efficient. And with recent tax changes, that gap is widening, not shrinking.

I know this goes against everything you've been told. The "incorporate to save tax" mantra is so ingrained in small business advice that questioning it feels almost heretical. But the numbers tell a different story than the one some accountants are selling, and I think you deserve to see them.

The advice that made sense... in 2015

Let's start with why everyone keeps repeating this incorporation advice. Back in the 2015/16 tax year, it was genuinely brilliant. If you were a basic rate taxpayer, you paid absolutely zero tax on dividends. Nothing. So you could set up a limited company, pay yourself a small salary, take the rest as dividends, and watch your tax bill shrink dramatically.

The maths was simple and compelling. Corporation Tax was 20%, dividend tax was 0% for basic rate, then up to 25% for higher rate tax payers, and limited companies were a genuine tax shelter. Accountants who pushed incorporation were giving sound advice.

But that was a decade ago. The tax landscape has transformed, and the advice hasn't kept up.

Fast forward to 2025, and dividend tax for basic rate taxpayers sits at 8.75%. From April 2026, it's jumping to 10.75%. For higher rate taxpayers, it's 33.75% (up to 35.75% in 2026). Corporation Tax ranges from 19% to 25%. The zero-tax dividend days are long gone, but somehow the "incorporate to save tax" advice persists like a zombie that refuses to die.

The double taxation trap after incorporation

Here's what changed: limited companies face double taxation and an additional employer NI. Your company pays NI on salary it pays you ( even though you pay it too!), then Corporation Tax when it earns the profit. Then you pay dividend tax when you extract that profit to actually use it. Two layers of tax on the same money.

Sole traders? Single taxation. You pay income tax and National Insurance on your profit, and that's it. The money is yours.

What the incorporation enthusiasts aren't telling you

Here’s what most people think about potential tax savings operating as Ltd: "Corporation Tax is only 19%, but as a sole trader you're paying 20% income tax plus 6% National Insurance. That's 26% total! Incorporating saves you 7%!"

Sounds convincing, right? Except that 7% saving gets devoured by other elements of tax burden placed on LTD’s.

First, there's Employer's National Insurance at 15% on anything you pay yourself above £5,000. If you take a salary of £12,570 to use up your personal allowance, that's £1,136 in Employer's NI right there. Already your 7% saving is looking questionable.

Then there's the dividend tax at 8.75% (soon 10.75%) on every pound you extract beyond your salary. Remember, you're already paid Corporation Tax on this money.

Add in the higher accountancy fees. A sole trader might pay £300 to £800 for their annual accounts and tax return. A limited company? You're looking at £1,000 to £3,500, plus payroll processing fees, plus the £34 Companies House confirmation statement.

Suddenly that 7% saving has evaporated, and you're potentially paying more to be "tax efficient."

The Employment Allowance complication

Now, if you have at least one employee who isn't a director, or you have two or more directors each earning above £5,000, your limited company can claim Employment Allowance. This covers up to £10,500 of Employer's National Insurance, which sounds like it solves the problem I just described.

But if you're a single director company with no employees, you can't claim it. And even when you can claim it, the benefit is smaller than it looks because reducing your Employer's NI increases your company's profit, which then gets taxed at 19-25% Corporation Tax. You don't get the full £1,136 saving back.

It helps, certainly. But it doesn't fundamentally change the story for most small businesses.

The numbers nobody wants to show you

I ran the actual calculations for different profit levels, comparing what you'd take home as a sole trader versus what you'd take home from a single director limited company using the optimal strategy of a £12,570 salary plus dividends. I used correct tax rates, proper marginal relief calculations, and realistic assumptions. No fudging the numbers to make incorporation look good.

For single director companies without Employment Allowance, here's what I found:

At £25,000 profit, you take home £806 more as a sole trader. At £35,000, you're still £815 better off as a sole trader. Even at £45,000 profit, the sole trader wins by £824. The conventional wisdom says you should have incorporated about now, but the numbers disagree.

At £50,000 profit, the sole trader still takes home £828 more. Then something interesting happens. At £60,000 profit, the limited company finally pulls ahead by £719. This is the sweet spot everyone talks about, and it's real. At this level, you're starting to pay 40% income tax as a sole trader on the marginal income, while most of your dividends as a director still fall in the basic rate band at 8.75%.

But here's where it gets weird. At £70,000 profit, you're essentially tied, with the limited company ahead by just £23. At £75,000, the sole trader wins again by £442. At £80,000, the sole trader is £907 ahead.

What's happening? Once your profits push your dividends into the higher rate band, you're paying 33.75% dividend tax on top of the Corporation Tax the company already paid. The double taxation becomes brutally expensive, and the sole trader's single layer of tax becomes more efficient again.

So the limited company advantage exists in a narrow band around £60,000 to £70,000 profit. That's it. A small window that most businesses either haven't reached yet or sail straight through.

With Employment Allowance, the picture improves slightly, but Ltd’s and sole traders essentially tie at most levels. At £35,000 profit, the limited company edges ahead by £24. At £50,000 you get £11 advantage on Ltd. At £60,000, the limited company is £1,300 ahead, and at £70,000, it's £576 ahead.

But remember, you need to subtract £1,000 to £4,000 in additional annual costs for higher accountancy fees, payroll, and Companies House compliance. Even a £1,300 tax advantage shrinks significantly when you factor in the real costs of running a limited company.

The flexibility you lose

There's another cost to incorporation that doesn't show up in tax calculations: flexibility.

As a sole trader, your business bank account is essentially an extension of your personal finances. Made £3,000 this month and need to buy a new personal phone? Transfer the money and buy it. Need to pay yourself £5,000 this month because your car died? Transfer it. The money is yours, and you can access it whenever you want with no paperwork.

As a limited company, everything changes. The company is a separate legal entity, and you cannot simply transfer money to yourself.

You can take a salary, but it must be processed through PAYE with tax and National Insurance deducted at source. You can take dividends, but only from distributable profits, which means you need completed accounts showing profit. In practical terms, you cannot pay yourself dividends in your first year of trading. If you incorporate on 6 April 2026, you won't see dividend payments until May 2027 at the earliest, after you've completed a full accounting period and had your accounts prepared and approved.

This creates a real problem in year one. The optimal tax strategy everyone talks about, the small salary plus dividends approach, simply isn't available. You're stuck taking everything as salary if you need the money to live on, which means paying 15% Employer's NI on most of it, plus all the income tax and Employee's NI on your side. Combined with the higher accountancy fees and Companies House compliance costs, you could easily find yourself several thousand pounds worse off in year one compared to staying sole trader.

You can also borrow money from your company through a director's loan, but if you don't repay it within nine months and one day after your company's year-end, the company pays section 455 tax at 33.75% of the loan amount (same as higher rate dividend tax rate). This tax is refundable when you repay the loan, but it ties up cash flow and creates compliance headaches.

When incorporation actually makes sense

Given everything I've just shown you, when should you actually incorporate?

The answer in recent years is almost never for tax reasons alone, at least not at the profit levels most small businesses operate at. But there are genuine, compelling reasons to incorporate that have nothing to do with saving a few hundred pounds in tax.

You should incorporate if you need limited liability protection. If you're taking on significant financial risk through large contracts, potential litigation exposure, or loans for inventory and equipment, the corporate veil protects your personal assets. This is a business protection decision, not a tax optimization decision.

You should incorporate if clients require it. Many corporate clients simply won't contract with sole traders. If incorporation unlocks £100,000 worth of contracts, spending a few thousand extra in tax and compliance costs is completely irrelevant.

You should incorporate if you want to retain profits for genuine reinvestment. If you're earning £80,000 but only need £40,000 to live on, keeping that £40,000 in the company taxed at 19-25% Corporation Tax beats extracting it personally and paying 40% income tax. But this only works if you genuinely don't need to extract the money, and you're not just deferring the inevitable dividend tax bill.

You should incorporate if you're building something to sell. Companies are far more saleable than sole trader businesses. If you're building for an exit, the corporate structure adds real value regardless of annual tax efficiency.

You should incorporate if you need to bring in investors or partners. Share structures, equity splits, and external investment all require a limited company framework.

And you should incorporate if you have employees and want flexibility with pensions and benefits. Employer pension contributions, company cars, and certain employee benefits could work better through a limited company structure.

When to stay sole trader

On the flip side, you should stay sole trader if you're a single-person business earning under £100,000. The tax numbers simply don't justify the complexity and cost for most people in this position.

You should stay sole trader if you need to extract most or all of your profit to live on. If you need the money, the double taxation of Corporation Tax followed by dividend tax and double NI charge makes limited companies less efficient than the single taxation of sole trader status.

You should stay sole trader if you value simplicity and flexibility. Being able to draw money freely, minimal paperwork, lower costs, and simpler tax returns matter. Your time and sanity have value too.

You should stay sole trader if you're in your first few years of business. Testing a business model while juggling limited company compliance is painful and expensive. Give yourself space to figure out what you're building before adding structural complexity.

And you should stay sole trader if your profit fluctuates significantly. Sole trader status makes it easy to scale up and down with your income. Limited companies create complexity when profits vary, especially around dividend planning and optimal extraction strategies.

The inconvenient truth

The "right time" to incorporate for tax reasons alone is much later than most people think, if it ever arrives at all.

The brief tax advantage that limited companies offer around £60,000 to £70,000 profit is too narrow and unreliable to base your entire business structure on. It assumes your profit stays in that exact range, that you can claim Employment Allowance and that the marginal tax savings outweigh the substantial increase in compliance costs and administrative burden.

For most single-person businesses, that's a lot of assumptions that rarely align with reality.

The real reasons to incorporate are about business structure, legal protection, professional credibility, and growth strategy. They're strategic decisions about where your business is going, not tactical decisions about saving a few hundred pounds this year.

If you're incorporating "to save tax" because that's what everyone does, because you've hit some arbitrary profit threshold, or because your accountant suggested it without running your specific numbers, you might be walking into a more expensive, more complex structure for little to no benefit.

The "incorporate at £50,000" rule of thumb made perfect sense couple of years ago. It makes very little sense in 2026.

Run your actual numbers. Look at your real costs. Consider your genuine need for limited liability, professional credibility, or corporate structure. Make the decision based on your specific circumstances, not outdated advice from the zero-dividend-tax era.

Sometimes the boring, simple answer is the right one. For most small businesses, that means staying sole trader longer than you've been told.