If you are freelancing in the UK and your income is growing, you have probably asked yourself whether setting up a limited company makes sense. This article walks through the real tax differences, the admin involved, the risks to watch for and the point at which incorporation usually starts to pay off. It is aimed at self-employed freelancers, whether you are a consultant, designer, developer, copywriter or any other kind of independent professional, who want a straight answer rather than a sales pitch. If you work in IT on day-rate contracts, our accountant for IT contractors page covers IR35 and pay planning in more detail.
- Sole trader vs limited company: the basics
- How the tax works differently
- When does incorporating make financial sense?
- The admin and running costs of a limited company
- IR35: the rule that changes everything
- Other things worth thinking about
- Making the decision
- Frequently asked questions
Sole trader vs limited company: the basics
As a sole trader, you and your business are legally the same entity. All business profits are yours, and you pay Income Tax and National Insurance on them through self assessment.
A limited company is a separate legal entity. It has its own bank account, files its own tax returns and pays corporation tax on its profits. You are a director and shareholder of that company, not the company itself. That distinction matters legally and financially.
Both structures are used by freelancers across every sector. The question is which one suits your current situation.
How the tax works differently
This is where most of the conversation about incorporation happens, and rightly so. The tax treatment between the two structures is meaningfully different once your profits reach a certain level.
As a sole trader
In 2026/27, you pay Income Tax on profits above the £12,570 personal allowance. The rates are:
- 20% on profits between £12,570 and £50,270
- 40% on profits between £50,270 and £125,140
- 45% on profits above £125,140
On top of that, you pay Class 4 National Insurance at 6% on profits between £12,570 and £50,270 and 2% above that. Class 2 National Insurance has not been compulsory since April 2024. If your profits are above the small profits threshold, you receive National Insurance credits without paying it.
The total tax burden at, say, £60,000 profit is significant. You have very little flexibility in how you take that money out.
As a limited company director
The company pays corporation tax on its profits. For 2026/27, that is 19% if profits are under £50,000. Above £250,000, the main rate of 25% applies. Between those figures, marginal relief reduces the effective rate gradually.
You then pay yourself through a combination of salary and dividends: the classic tax-efficient extraction method. A typical strategy looks like this:
- Pay yourself a salary up to the employer National Insurance threshold (£5,000 in 2026/27) or up to the personal allowance (£12,570)
- Draw the rest of your income as dividends
- Use the £500 dividend allowance before dividend tax kicks in
- Pay dividend tax at 10.75% (basic rate), 35.75% (higher rate) or 39.35% (additional rate) on dividends above the allowance
The combined tax rate on money flowing through a limited company is often lower than paying Income Tax and NI as a sole trader, particularly once you are earning above the basic rate threshold of £50,270.
A worked example
Say your freelance turnover is £80,000 and your allowable business expenses are £10,000, leaving £70,000 in profit.
As a sole trader: You would pay Income Tax and NI on £70,000. After the personal allowance of £12,570, you would have roughly £57,430 of taxable profit. A large slice of that falls in the higher rate band. Your total tax and NI bill would be substantial: well over £20,000 in most cases (confirm exact figures with a tax adviser or HMRC calculator).
As a limited company: The company pays corporation tax at 19% on its profits (assuming they fall under £50,000 after your salary is deducted as a company expense). You take a small salary and draw dividends for the remainder. You can also leave surplus profit in the company to draw in a later year, which gives you more control over when you pay personal tax.
When does incorporating make financial sense?
There is no single income level at which incorporation automatically becomes more tax efficient. The right structure depends on your profits, personal income requirements, other income, how much you plan to retain, pension contributions, extraction strategy and the additional costs and responsibilities of running a company.
The case becomes stronger when:
- Your profits are high and consistent
- You do not need to draw all of your profit as income each year
- You are contracting through a business-to-business arrangement (not caught by IR35)
- You have a business partner or want to bring in investors
- You want to protect personal assets from business liability
The case is weaker when:
- You are just starting out with an uncertain income
- You rely on drawing every penny of profit to cover living costs
- Your contracts are likely to fall inside IR35
- You find financial admin difficult to keep on top of
The admin and running costs of a limited company
This is where freelancers often underestimate what is involved. A limited company comes with real obligations that do not exist for sole traders.
Filing requirements
- Annual accounts filed at Companies House
- A corporation tax return filed with HMRC
- Confirmation statement (annual return) at Companies House
- Personal self assessment tax return for the director
- VAT returns if your turnover exceeds the registration threshold of £90,000 (in 2026/27)
- Payroll filings if you pay yourself a salary, including RTI submissions to HMRC
That is a material increase in paperwork. Most freelancers running a limited company use an accountant to handle their bookkeeping, payroll and filings, which costs money but removes the burden from you.
Typical accountancy costs
You will pay an accountant to handle the compliance a limited company needs, and the cost depends on how much work your company generates. This is a real cost, and you need to factor it in when calculating whether incorporation saves you money overall.
Other running costs
- Business bank account fees
- Companies House filing fees
- Accounting software (such as Xero, which our bookkeeping service sets up and runs for you)
The net tax saving needs to exceed these costs to make incorporation worthwhile. At lower profit levels, it often does not.
IR35: the rule that changes everything
If you work through a limited company but your working arrangements look like employment, HMRC may say your income should be taxed as employment income. That is IR35: the off-payroll working rules.
IR35 applies when a contractor works through a personal service company (PSC) but would be treated as an employee if hired directly. The factors HMRC looks at include:
- Whether you are under the client’s direction and control
- Whether you can send a substitute if you are unavailable
- Whether you are financially integrated into the client’s business
- Whether you bear financial risk
Since April 2021, medium and large private sector clients are responsible for deciding your IR35 status. If they determine your contract falls inside IR35, they deduct Income Tax and NI before paying you and the tax advantage of operating via a limited company disappears almost entirely.
If most of your work comes from one or two large clients, and they have deemed your engagement to be inside IR35, setting up a limited company gives you extra admin with no tax benefit. In that situation, staying as a sole trader or moving to an umbrella company is often more practical.
If you genuinely operate outside IR35 (multiple clients, control over how you work, ability to send a substitute) a limited company can still be the right structure.
Other things worth thinking about
Limited liability
As a sole trader, you are personally liable for business debts. If a client sues you and wins a large judgement, your personal assets, including your home, are at risk. A limited company provides a legal barrier between your personal finances and your business finances. This matters more in some freelance sectors than others.
Professional credibility
Some clients, particularly larger businesses, prefer to contract with limited companies rather than sole traders. It signals a degree of permanence and professionalism. It also means the client can pay a company rather than an individual, which some procurement teams require. This is not universal, but it is worth thinking about in your sector.
Pension contributions
A limited company can make employer pension contributions directly from company profits. These are a deductible business expense, which means the company pays no corporation tax on that money and you pay no Income Tax or NI on it either, up to the £60,000 annual pension allowance in 2026/27. This is one of the most tax-efficient ways to extract value from a company and build long-term wealth.
Making Tax Digital
From April 2026, self-employed individuals and landlords with income over £50,000 must comply with Making Tax Digital for Income Tax Self Assessment. This means quarterly digital reporting to HMRC. Limited companies are not in scope for MTD for ITSA. They operate under a separate corporation tax regime. This is worth knowing if your freelance income is above that threshold and you are weighing up your options.
Cash flow management
Running a company requires proper separation of personal and business finances. Good cash flow management becomes more important when tax liabilities sit inside the company and need to be paid at specific dates. Corporation tax is due nine months and one day after your company’s year end. Do not spend it.
Making the decision
The honest answer is that there is no single right answer for every freelancer. The decision depends on your profit level, your working arrangements, your risk appetite and how you want to run your finances day to day.
Here is a simple way to frame it:
- Profit under £30,000: Stay as a sole trader. The tax savings will not cover the extra costs.
- Profit £30,000 to £50,000: Run the numbers with an accountant. Incorporation may or may not make sense depending on your circumstances.
- Profit above £50,000, outside IR35: A limited company is worth serious consideration. The tax saving is real and often significant.
- Profit above £50,000, inside IR35: The tax advantage is largely removed. Focus on whether you need the liability protection instead.
Speak to an accountant before you make the move. Incorporation is reversible, but closing a company down has its own costs and complications. Getting the structure right from the start is far easier than unpicking a decision made in haste.
If you are a freelancer trying to work out the best structure for your income, we work with independent professionals across a range of sectors and can model the numbers for your specific situation. The right structure is the one that fits how you actually work, not just the one with the lowest headline tax rate.
Frequently asked questions
At what income level should a freelancer consider a limited company?
There is no single income level at which incorporation automatically becomes more tax efficient. The right structure depends on your profits, personal income requirements, other income, how much you plan to retain, pension contributions, extraction strategy and the additional costs and responsibilities of running a company.
Can a freelancer be both a sole trader and a limited company director?
Yes. You can be a sole trader for some activities and a director of a limited company for others. However, this adds complexity and is not usually necessary. If you are considering this, speak to an accountant to understand the tax and reporting implications for each income stream.
How much does it cost to set up a limited company in the UK?
Registering a limited company at Companies House costs £50 online (check the Companies House website for the current fee). The bigger costs are ongoing: accountancy fees, bank account charges and software. Budget at least £1,000 to £2,400 per year in professional fees to keep everything compliant.
Do I need to register for VAT if I set up a limited company?
Not automatically. VAT registration is required once your taxable turnover exceeds £90,000 in a rolling 12-month period in 2026/27: the same threshold applies whether you are a sole trader or a limited company. You can also register voluntarily below that threshold, which some freelancers choose to do.
What is the most tax-efficient way to pay myself from a limited company?
The most common approach is a small salary (typically up to the personal allowance of £12,570 or the employer NI threshold of £5,000 in 2026/27) combined with dividends from retained profits. Adding employer pension contributions directly from the company can further reduce the tax cost. The right balance depends on your personal tax position, so take advice specific to your situation.
What happens if HMRC decides my limited company contracts fall inside IR35?
If your engagement is assessed as inside IR35, the fee payer (usually your client or agency) deducts Income Tax and National Insurance from your payments, similar to employment. The corporation tax advantage is largely lost. You would still have company running costs but without the tax benefits, which is why IR35 status needs to be assessed before you decide to incorporate.
Need an accountant for your limited company?
NDCA is an ACCA-regulated accountancy practice with fixed monthly fees and a named accountant. Book a free consultation and pick a time that suits you.
