What Is the Difference Between Self Employed and Limited Company Tax

At Towerstone Accountants we provide specialist personal tax services, for self employed, and individuals across the UK. This article has been written to explain What is the difference between self employed and limited company tax, in clear practical terms, so you understand how personal tax and Self Assessment rules apply in real situations. Our aim is to help you stay compliant, avoid costly mistakes, and make confident tax decisions.

This is one of the most important questions anyone running a business in the UK will ever ask and in my experience it is also one of the most misunderstood. People often assume that choosing between being self employed or operating through a limited company is mainly about paperwork or image. In reality the tax differences are fundamental and they affect how and when you pay tax how much control you have over cash flow and how exposed you are personally.

I deal with this question almost every week. Sometimes it comes from someone just starting out. Other times it comes from a sole trader whose profits have grown and who has heard that a limited company is more tax efficient. Occasionally it comes from someone who has incorporated without fully understanding the implications and now feels unsure whether they made the right decision.

In this article I want to explain clearly and honestly how tax works for self employed individuals compared to limited companies. I will cover how profits are taxed how money is taken out of the business the timing of tax payments and the practical pros and cons I see in real life. This is based on current UK rules and on years of advising clients in both structures.

The starting point. What you are in law and tax terms

The most important difference between being self employed and running a limited company is legal identity.

When you are self employed you and the business are the same person in the eyes of the law and HMRC. There is no separation. All profits belong to you personally and you are personally responsible for the tax.

A limited company is a separate legal entity. The company owns the profits not you. You control the company but you are not the same thing as it. That separation is the foundation of all the tax differences that follow.

Once people truly understand this the rest of the comparison starts to make sense.

How tax is calculated for self employed people

As a self employed sole trader tax is calculated on your business profit. Profit is your income minus allowable business expenses. It does not matter how much money you take out of the business. Tax follows profit not drawings.

Each year you report your figures through a Self Assessment tax return. HMRC then calculates your income tax and National Insurance based on those profits.

You pay income tax at the standard personal rates. You also pay Class 2 and Class 4 National Insurance depending on your profit level. All of this is bundled together into one tax bill.

From experience this is where many people get caught out. Because nothing is deducted during the year the tax bill can feel large if no money has been set aside.

How tax is calculated for limited companies

With a limited company the company itself pays tax first. This is Corporation Tax which is charged on the company’s profits.

Once Corporation Tax has been paid the remaining profit can either be kept in the company or paid out to you as the director or shareholder. How you take that money out determines how much personal tax you pay.

This creates two layers of tax. One at company level and one at personal level. That sounds worse at first but it also creates planning opportunities that do not exist for sole traders.

In practice this is where a lot of tax efficiency can be achieved but only when it is done properly.

How you get paid as a sole trader versus a director

As a sole trader you do not pay yourself a salary. You simply take drawings from the business. These drawings are not an expense and they do not affect your tax bill.

As a director of a limited company you can pay yourself in different ways. Typically this involves a salary through payroll and dividends from profits.

Salary is taxed under PAYE with income tax and National Insurance deducted. Dividends are taxed differently and often at lower rates depending on your overall income.

This difference in how money is extracted is one of the biggest practical distinctions between the two structures.

Timing of tax payments

Timing is an area where the difference is felt very clearly.

As a self employed person you usually pay your tax in January following the end of the tax year. You may also pay payments on account in January and July towards the following year.

This means you can be paying tax on profits you earned many months earlier. Cash flow planning becomes essential.

With a limited company Corporation Tax is paid nine months and one day after the end of the accounting period. Personal tax on salary is paid monthly through PAYE and dividend tax is paid through Self Assessment.

This spreads the tax burden differently and often gives more control over timing especially as profits grow.

National Insurance differences

National Insurance is another key area of difference.

Self employed individuals pay Class 2 and Class 4 National Insurance based on profits. This is calculated through Self Assessment and paid alongside income tax.

Directors pay National Insurance on salary through payroll. Dividends do not attract National Insurance at all.

From experience this is one of the reasons limited companies can become more tax efficient at higher profit levels. The absence of National Insurance on dividends makes a noticeable difference.

How expenses and allowances compare

Allowable expenses are broadly similar in both structures. Genuine business costs can usually be claimed in either case.

However limited companies often have slightly more flexibility around certain benefits and allowances such as pensions and some benefits in kind.

This does not mean a limited company is always better but it does mean the planning options are wider.

Liability and risk

Although this article focuses on tax it would be wrong not to mention risk.

As a sole trader you are personally liable for business debts and tax. If something goes wrong your personal assets can be at risk.

A limited company offers limited liability. In most cases your personal assets are protected if the company fails provided you have acted properly.

From experience this becomes more important as businesses grow or take on contracts and staff.

Administration and compliance

This is where self employment often feels simpler.

Sole traders have fewer formal requirements. There are no statutory accounts filed publicly and compliance is generally lighter.

Limited companies have more obligations. Annual accounts confirmation statements Corporation Tax returns payroll submissions and Companies House filings all come with deadlines.

This does not mean limited companies are unmanageable but it does mean they require more structure and usually professional support.

Is one always more tax efficient than the other?

This is the question everyone really wants answered.

The honest answer is no. There is no one size fits all rule.

At lower profit levels self employment is often simpler and sometimes more tax efficient once costs are considered. As profits increase a limited company often becomes more efficient but only when the structure is used properly.

From experience the tipping point is not just about profit. It is about how much money you need personally how much you can leave in the business and your long term plans.

Blindly incorporating for tax reasons without understanding the full picture often leads to disappointment.

Common mistakes I see in practice

One common mistake is people comparing headline tax rates without understanding how profits are extracted.

Another is people incorporating too early and increasing costs and complexity without meaningful savings.

I also see people remain self employed too long and miss planning opportunities because they are wary of change.

The right decision is rarely obvious without looking at the full financial picture.

How an accountant helps with this decision

This is one of the most valuable conversations I have with clients.

A good accountant will not push incorporation just because it sounds tax efficient. They will model the numbers properly look at cash flow consider risk and explain the trade offs clearly.

From experience once people see the figures laid out calmly the decision becomes much easier.

Key points to takeaway

The difference between self employed and limited company tax goes far beyond rates and percentages. It affects how profits are taxed how money is taken out when tax is paid and how much flexibility you have.

Self employment is simple and direct. You are taxed on profits and you take drawings as needed. Limited companies introduce another layer of tax but also far more planning opportunities and protection.

In my experience the right structure depends on the stage of the business the level of profit and the individual behind it. Understanding the differences properly is the first step towards making a confident decision rather than one based on hearsay or guesswork.

You may also find our guidance on Should I pay myself a salary or draw money as a sole trader, and How do I switch from sole trader to limited company, helpful when reviewing related personal tax questions. For a broader overview of Self Assessment deadlines, reporting, and obligations, you can visit our self assessment guidance hub.