Here's the key tax implications for every self-employed business structure

While being self-employed comes with freedom from the rules of a 9-5 job, it also means you are fully responsible for your own financial success or failure.

Your new role can involve being everything from chief financial officer and accountant to marketing lead and business administrator.

It also arrives hand-in-hand with varying tax considerations, as well as the pressure of choices over the legal structure you want your business to follow.

There are three main legal structures when it comes to being self-employed: sole traders, limited companies and partnerships. Each option has different benefits and drawbacks.

Acting as a sole trader is the most common form of self-employment and sees one person own and run a business. 

Meanwhile, a limited company is legally separate from the people who own it, while partnerships involve shared responsibility.

One type of limited company is a personal service company (PSC). This is a limited company which is typically controlled by a single director or contractor.

On top of these options, many people work as umbrella workers. Such workers are temporary contractors or freelancers who are employed by an umbrella company rather than by an end-client.

For the purposes of this article, we will be looking at the differences between sole traders, limited companies, PSCs, and umbrella workers; and the tax considerations they face.

A sole trader is a form of self‑employment in which you and the business are legally the same entity. 

You keep all the profits your organisation makes after tax, but are responsible for all debts. Sole traders must register with HMRC and file for self-assessment if they earn more than £1,000 per tax year.

It involves a lot less paperwork than becoming a limited company, but if the worst happens financially then you can end up being personally liable.

Tax implications for sole traders

Sole traders pay Income Tax on any profits they make, as well as National Insurance contributions. What you need to pay is calculated via your self-assessment form.

There is a personal, tax-free allowance of £12,570 on profits, with this figure set to remain the same in 2026/27. Income tax is then paid at a basic rate of 20% on income between £12,571 and £50,270.

There is then a higher 40% rate of income tax for anyone whose profits fall between £50,271 and £125,140; while those who make more than that must pay an additional rate of 45%.

In terms of National Insurance, if you make profits between £12,570 and £50,270 then you will need to pay Class 4 contributions at 6%. This drops to 2% on any profits which exceed £50,270.

There are also voluntary Class 2 contributions to consider. Those who make a profit lower than £7,105 don’t have to make Class 2 National Insurance, but will lose access to certain benefits including the state pension for the period they don’t pay. You can make a voluntary payment of £3.65 per week to maintain your National Insurance record. Anyone making a profit of more than £7,105, is considered to have paid Class 2 National Insurance.

As a sole trader, you are personally responsible for taxes on all your profits.

A limited company is a separate legal entity, with self-employed individuals acting as shareholders and directors. This means the company itself can own property, incur debts, and be sued. 

Such organisations must be registered with Companies House, pay corporation tax, and will remain in existence regardless of any changes of ownership.

One of the main advantages of running this kind of company is limited liability, which means you’re only liable for the amount you’ve invested in the company. 

A limited company must be registered with Companies House in order to pay any salaries, expenses, or benefits.

Tax implications for limited companies

Limited companies have to pay corporation tax on company profits. This is a tax paid on profits accrued during an accounting period, and the amount paid depends on profit levels.

Corporation tax must also be paid if a limited company makes profits on any investments or from selling any assets for more than they costed.

When registering your company on Companies House, you will also be prompted to set up for corporation tax. The main rate for corporation tax is 25% for profits over £250,000, while companies with profits between £50,001 and £250,000 are subject to a marginal increased rate of 26.5%. Those companies with profits of £50,000 or less pay a small profits rate of 19%.

Limited companies must also register for VAT if their taxable turnover for 12 months is more than £90,000, known as the VAT threshold, or if that turnover is expected to go over £90,000 within the next 30 days. The standard VAT rate is 20%.

When it comes to salaries, some directors may take into consideration the £12,570 personal allowance which effects national insurance payments – the rest or a proportion of the remainder could then be allocated to dividends. 

Dividends are tax free up to £500 and are then taxed at lower rates than salaries are. The amount of tax you pay above the dividend allowance depends on your income tax band. From the 2026/27 tax year, the basic rate will be 10.75%, with a higher rate of 35.75% and an additional rate of 39.35%.

To receive dividends, you must be a shareholder and they can only be paid if a limited company is making sufficient profit.

A PSC is a limited company, usually controlled by a single director or shareholder who acts as a contractor. The PSC is used to provide professional services to clients.

Rather than being employed directly, the PSC contracts with clients or agencies to provide services.

A PSC is not a legally defined entity, but the term is widely used to describe such contractor-controlled operations.

Tax implications for PSCs

PSCs can pay themselves through company dividends rather than salary, which reduces the overall levels of tax and national insurance which they have to pay.

This has led successive governments to look closely at such arrangements, most notably in 2017 through off-payroll rules, and in April 2000 with the introduction of IR35 legislation.

In short, IR35 rules aim to prevent contractors from benefiting from limited‑company tax breaks when they are effectively employees.

If a contractor is deemed to be genuinely self-employed for tax purposes – in other words, to be working ‘outside IR35’ – then this becomes a tax-efficient option. However, if they are ‘inside IR35’, then these tax advantages largely disappear and income is taxed similarly to if someone is conventionally employed.

As PSCs are limited companies, they are subject to corporation tax and, if they qualify, for VAT in the same way as any other such company.

An umbrella worker is a temporary worker or contractor who is employed by an umbrella company, rather than directly by an end-client or agency. This option is often chosen by contractors who are working inside IR35.

It sees the umbrella company manage your payroll (PAYE), tax deductions, and employment rights. This allows workers to move between short-term assignments while maintaining continuous employment.

In most cases, umbrella workers find work through recruitment agencies. They then carry out work for one of the agencies clients, while being employed by the umbrella company.

Tax implications for umbrella workers

Umbrella workers are considered employees for tax purposes. The umbrella company deducts income tax and national insurance, as well as any pension contributions.

As with any other employed individual, these deductions are taken out of your gross pay. It is the responsibility of the umbrella worker to ensure they are paying the correct amount of tax and national insurance, and while most umbrella companies follow tax rules, some may promote tax avoidance schemes. This means it is important to have access to your payslips and to review them regularly.