In this excerpt from the our brand new tax book ‘101 Practical Tax Tips’, Sarah Bradford looks into whether incorporation remains worthwhile for the self-employed in light of recent tax and National Insurance changes.
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It can still be beneficial to incorporate and extract funds by taking a small salary and extracting further profits in the form of dividends (see Tips 25, 26 and 27). However, increases in the rates of corporation tax, employer’s National Insurance and dividend tax a cut in the dividend allowance, the abolition of Class 2 National Insurance contributions and the cut in the main rate of Class 4 National Insurance contributions have reduced the advantages of incorporation in recent years and muddied the waters, meaning that now incorporation is not always beneficial and will depend on the profit levels. There is no substitute for doing the sums.
A self-employed trader will pay income tax on their profits at 20% where these fall in the basic rate band, at 40% where these fall in the higher rate band and at 45% where these fall in the additional rate band. They will also pay Class 4 National Insurance contributions at 6% on profits between £12,570 and £50,270 and at 2% on profits in excess of £50,270.
For a personal company, a typical tax-efficient profit extraction strategy is to pay a small salary and to extract further profits as dividends. For 2025/26, assuming the personal allowance has not been used up elsewhere, the optimal salary is £12,570, equal to the personal allowance and the primary threshold.
Dividends do not attract National Insurance contributions, so by incorporating and extracting profits as dividends, you will save Class 4 National Insurance contributions. Dividends also benefit from a tax-free dividend allowance, set at £500 for 2025/26.
Once the dividend allowance has been used up, dividends, taxed as the top slice of income, are taxed at 8.75% to the extent they fall in the basic rate band, 33.75% to the extent that they fall within the higher rate band and at 39.35% where they fall in the additional rate band.
It should be noted that dividends can only be paid from retained profits and for each class of share, shareholders must receive dividends in proportion to their shareholdings.
The company is a separate legal entity which pays corporation tax on its profits. From 1 April 2023 onwards, the rate of corporation tax depends on the level of profits. A small profits rate of 19% applies where taxable profits do not exceed the lower limit, with a main rate of 25% applying where taxable profits are more than the upper limit. However, the effective rate is reduced by marginal relief where profits are between the lower limit and the upper limit.
Where the company has no associated companies, the lower limit is £50,000 and the upper limit is £250,000. If the company has one or more associated companies, these limits are divided by the number of associated companies plus one. The limits are reduced proportionately where the accounting period is less than 12 months. The rate at which corporation tax is paid will affect the post-tax profits available for distribution as a dividend.
As personal circumstances differ, there is no substitute for crunching the numbers. Consideration should also be given as to whether the costs of incorporation outweigh the tax and National Insurance savings.
Self-Employed? Is Incorporation Worthwhile?
Harry is a sole trader, making profits of £50,000 a year. If he remains self-employed, in 2025/26, he will pay tax of £7,486 ((£50,000 – £12,570) @ 20%) on his profits. He will also pay Class 4 NICs of £2,245.80 ((£50,000 – £12,570) @ 6%). His total tax and NIC bill will be £9,731.80 leaving him with profits of £40,268.20.
If he incorporates the business and pays himself a salary of £12,570, assuming he is the sole employee and the director, he will not be entitled to the Employment Allowance. Therefore, the company will pay secondary NICs on the salary of £1,135.50 ((£12,570 – £5,000) @ 15%). The salary and the employer’s NIC are deductible in computing the company’s taxable profits, reducing the taxable profits to £36,295. As the profits are below the lower profits limit of £50,000, the company pays corporation tax at 19%, a tax bill of £6,8966, leaving post-tax profits of £29,399 to be extracted as a dividend.
The first £500 of the dividend is tax-free. The remaining £28,899 is taxed at 8.75%, a tax bill of £2,528.66 leaving him with £26,870.34 of the dividend. Together with the salary of £12,570, Harry retains £38,440.34 of his profits.
For 2025/26, he is marginally better off by remaining self-employed. He also saves the additional administration associated with running a company. However, if he incorporates, he will have the choice as to whether to extract income from the company and pay personal taxes on it or leave it in the company and only incur corporation tax on his profits.
