What Happens to Your Sole Trader Losses When You Incorporate? (And How to Not Waste Them)
- Ewa Kilicaslan
- Dec 13, 2025
- 8 min read
You've been running your business as a sole trader for a few years. The first year was rough - you made a loss. Maybe the second year too. But now you're profitable and you're planning to incorporate into a limited company for tax efficiency in the next few months.
Here's the question nobody seems to answer clearly: what happens to those losses you've been carrying forward?
The short answer? They don't transfer to your new limited company, but they don't have to go to waste either. There's a specific tax relief designed exactly for this situation - if you structure your incorporation properly.
Why your losses don't automatically transfer
When you incorporate, you're creating a completely separate legal entity. Your limited company is a different "person" in the eyes of HMRC. It didn't make those losses - you did, as a self-employed individual.
Your sole trader losses remain on your personal Self Assessment tax return. Your new company starts with a clean slate - zero losses, zero history.
But here's what most people don't know: there's a specific relief called pre-incorporation loss relief that lets you use those carried-forward losses against income you receive from your new company.
Pre-incorporation loss relief: the solution
If you transfer your sole trader business to a limited company in exchange wholly or mainly for shares in that company, you can use your carried-forward sole trader losses against income you receive from the company. This includes both salary and dividends.
The conditions:
You must transfer your trade to the company in exchange for shares (not just close down as a sole trader and start a separate new company)
The company must continue carrying on the same trade
You must remain the beneficial owner of those shares
The relief is limited each year to the lower of: your carried-forward losses, or your income from the company that year
What this means in practice:
Let's say you have £15,000 in carried-forward sole trader losses. You cease sole trader trading on 5 April 2026 and incorporate on 6 April 2026, transferring your trade to the company in exchange for shares.
Important: Your company cannot pay dividends in its first year of trading. Dividends can only be paid from distributable profits, which requires the company to have completed an accounting period, prepared accounts showing a profit, and confirmed sufficient reserves. With a typical 12-month accounting period starting 6 April 2026, you won't be able to take dividends until after 5 April 2027 at the earliest.
So in 2026/27, salary is your only income from the company. You can claim pre-incorporation loss relief to offset your losses against that salary - but as we'll see below, this usually isn't the smart move in year one.
The "transfer of trade" requirement
This is crucial: you must transfer your trade to the company, not just shut down as a sole trader and start afresh.
What counts as a transfer:
You incorporate your existing sole trader business
The company takes over your client relationships, contracts, and goodwill
The company continues the same business activities
You receive shares in the company in exchange for the business
What doesn't count:
You close your sole trader business completely
You start a different business in the company
You sell your business to the company for cash rather than shares
The company is doing something substantially different from your sole trader activities
This is why proper incorporation planning matters. Your accountant should be documenting this as a transfer of trade, not a cessation followed by a new start.
Planning your incorporation timing for 2026
If you're planning to incorporate on 6 April 2026, now is the time to plan how you'll use your losses.
Key planning points:
1. Structure it as a transfer of trade
Make sure your incorporation is documented properly. The company should be acquiring your business (including goodwill, client relationships, work in progress) in exchange for shares.
2. Understand the multi-year picture
Unlike some loss reliefs that have tight deadlines, pre-incorporation loss relief can be carried forward year after year, as long as:
The company continues the same trade
You continue owning the shares
You continue receiving income from the company
This means there's no rush to use all your losses in 2026/27. You can spread them across multiple years as makes sense for your tax position.
3. The salary decision for year one - why waiting usually makes sense
Since you can't take dividends in your first year, salary is your only way to use losses in 2026/27. But here's why that's usually a bad idea:
Let's say you have £15,000 in carried-forward losses.
Option A: Pay yourself £30,000 salary to use your losses in 2026/27
Employers' NI: £3,749.40
Employee NI: £1,393.92
Total NI paid: £5,143.32
Income tax without loss relief: £3,486
Income tax with £15,000 loss relief: £486
Tax saved through loss relief: £3,000
Net position: You pay £5,143 in NI to save £3,000 in tax - you're £2,143 worse off
Option B: Pay yourself £12,570 salary (personal allowance) and preserve your losses
Employers' NI: £1,134.84
Employee NI: £0
Total NI paid: £1,134.84
Income tax: £0 (within personal allowance)
Losses carried forward to use in 2027/28 when dividends are available
Net position: Pay £1,135 in NI, preserve £15,000 losses for when they're actually valuable
The verdict: Don't rush to use your losses in year one.
Unless you were going to pay yourself that higher salary for living expenses, it makes no financial sense to pay yourself extra salary just to use your losses. You'll pay over £4,000 more in National Insurance to save £3,000 in income tax.
Instead, take minimum salary in 2026/27, pay the £1,135 in employers' NI, and carry your £15,000 losses forward to 2027/28. Once dividends become available, you can use those losses against dividend income, which doesn't attract National Insurance at all.
4. When using losses in year one does make sense
There is one scenario where using losses against salary in 2026/27 makes sense: if you were going to pay yourself that salary anyway for living expenses.
If you genuinely need £30,000 to live on in 2026/27, then you might as well claim the loss relief and save £3,000 in tax, even though you're paying £5,143 in NI. You were going to pay that NI regardless.
But don't artificially inflate your salary just to use losses. That's throwing money away.
Don't forget terminal loss relief
Pre-incorporation loss relief only applies to losses you're carrying forward from previous years. But what about losses made in your final period of sole trader trading?
If you make a loss in the final 12 months before ceasing on 5 April 2026, you can claim terminal loss relief to carry that loss back against profits from the same trade in 2025/26 and the previous three years.
This generates actual cash refunds on tax you've already paid - which can be very helpful when you're setting up your limited company.
Example:
You're planning to cease on 5 April 2026. In the period from 6 April 2025 to 5 April 2026, you make a £10,000 loss (perhaps because you've been investing in new equipment or had a quiet period before the transition).
You can carry this £10,000 loss back against your 2025/26 profits, 2024/25 profits, 2023/24 profits, and 2022/23 profits (in that order, starting with the most recent year).
If you made £15,000 profit in 2024/25, you can reduce that to £5,000 and get a refund on the tax you paid on that £10,000.
The overlap relief complication
If you've been a sole trader for years, you probably have overlap relief on your tax records from when you first started trading. This is a different type of relief (it relates to profits you were taxed on twice due to accounting period overlaps when you started).
When you cease sole trader trading on 5 April 2026, you can claim this overlap relief in your final year. It reduces your taxable profit for 2025/26.
Check your last Self Assessment tax return - the overlap relief amount should be shown on your self-employment pages. Make sure your accountant includes this when calculating your final year's tax bill.
Your action plan for a 2026 incorporation
If you're planning to cease sole trader trading on 5 April 2026 and incorporate on 6 April 2026:
Before 5 April 2026:
Check your Self Assessment tax return - how much in carried-forward losses do you actually have? (Box 25 on the self-employment pages)
Check your overlap relief amount
Work out if you'll make a profit or loss in your final sole trader year (6 April 2025 to 5 April 2026)
Calculate what salary you actually need to live on in 2026/27
When incorporating on 6 April 2026:
5. Structure it properly as a transfer of trade to the company in exchange for shares
6. Document what you're transferring (business name, goodwill, client relationships, work in progress, equipment)
7. Ensure your accountant records this as a business transfer, not a cessation and new start
For 2026/27 tax planning:
8. Set your salary at the level you need for living expenses and not any higher
9. Don't inflate your salary just to use losses - the NI cost outweighs the tax saving
10. Plan to use your carried-forward losses in 2027/28 onwards when dividends become available
11. Keep records showing you own the shares and the company is continuing the same trade
By 31 January 2028 (the deadline for your 2026/27 Self Assessment):
12. If you did take salary above the personal allowance and want to use some losses, claim pre-incorporation loss relief on your tax return
Common mistakes that waste losses
Mistake 1: Not structuring it as a transfer of trade
If you just close down as a sole trader and start a "new" business in a company, you won't qualify for pre-incorporation loss relief. The company must acquire your existing trade.
Mistake 2: Rushing to use losses in year one via inflated salary
Paying yourself £30,000 salary to use £15,000 of losses costs you over £2,000 more than just taking minimum salary and preserving the losses for year two. Don't fall into this trap.
Mistake 3: Thinking losses expire after one year
Unlike sideways relief against general income (which has tight time limits), pre-incorporation loss relief can be used for multiple years. You have time to use them strategically.
Mistake 4: Forgetting to actually claim the relief
Pre-incorporation loss relief isn't automatic. You need to claim it on your Self Assessment tax return each year. Make sure your accountant knows about your carried-forward losses and claims the relief when you do eventually use them.
Mistake 5: Expecting to take dividends in year one
Your company needs to complete a full accounting period and prepare accounts showing profit before dividends can be paid. Plan your 2026/27 finances around salary only.
The bottom line
If you're planning to incorporate in April 2026 and have carried-forward sole trader losses, those losses don't have to go to waste. Pre-incorporation loss relief lets you use them against income from your new company - potentially saving you thousands in tax.
But it requires proper planning and patience:
Structure the incorporation as a transfer of trade for shares
Understand that salary is your only income option in year one
Don't rush to use losses in year one - the National Insurance costs usually outweigh the tax savings
Wait until 2027/28 when you can use losses against dividends (which don't attract NI)
Remember to actually claim the relief on your tax return when you do use the losses
This is exactly the kind of planning that should happen before you incorporate, not after. If your accountant hasn't discussed your carried-forward losses when planning your April 2026 incorporation, that's a conversation you need to have now.
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