How to Pay Yourself Tax-Efficiently as a Sole Trader or Limited Company

Introduction

As a small business owner, how you pay yourself directly impacts your take-home pay and tax bill. Getting this right can save you thousands, while mistakes can lead to unexpected tax demands or cash flow issues. Whether you’re a sole trader or run a limited company, this is one of the most common areas where small business owners slip up. This article breaks down the essentials of paying yourself tax-efficiently, tailored to your business structure, with practical tips to keep more of your hard-earned money.

Paying Yourself as a Sole Trader

As a sole trader, your business profits are your personal income, subject to Income Tax and National Insurance Contributions (NICs). There’s no formal salary or dividends—just “drawings,” which are withdrawals from your business account for personal use. However, drawings aren’t tax-free; you’ll still owe tax on your total profits, regardless of how much you withdraw.

Budgeting for Your Tax Bill

Sole traders pay Income Tax (20% basic rate, 40% higher rate, 45% additional rate for 2025/26) and Class 2/4 NICs on profits. A rough rule of thumb is to set aside 25-35% of your profits for taxes, depending on your income level. For example, if you earn £50,000 in profits, expect to owe around £12,500-£15,000 in tax and NICs. Use a separate savings account to avoid being caught short.

When You Pay Tax

Sole traders pay tax via Self Assessment, with deadlines on January 31 and July 31 each year. If your tax bill exceeds £1,000, you’ll likely make “payments on account”—two advance payments toward next year’s tax, due alongside your annual return. Plan for these to avoid cash flow surprises.

Paying Yourself from a Limited Company

Running a limited company offers more flexibility but added complexity. Most directors pay themselves a combination of a small salary and dividends, balancing tax efficiency with compliance.

Salary

A PAYE salary is subject to Income Tax and NICs. Many directors take a low salary (e.g., £9,100 in 2025/26, the NIC threshold) to minimize NICs while still qualifying for state pension credits. This salary is deductible from your company’s Corporation Tax.

Dividends

Profits after Corporation Tax can be paid as dividends, which are taxed at lower rates than income: 8.75% (basic), 33.75% (higher), and 39.35% (additional) for 2025/26. Dividends aren’t subject to NICs, making them tax-efficient for higher earners.

Example Comparison

Let’s say you want to pay yourself £30,000 from your company. Option 1: A £30,000 salary incurs about £5,800 in Income Tax and NICs (employee and employer). Option 2: A £10,000 salary plus £20,000 in dividends saves roughly £2,000 in tax, as dividends face lower rates and no NICs. However, dividends require sufficient post-tax profits, and you must follow HMRC rules to avoid penalties.

Other Points to Consider

Pension Contributions

Paying into a pension is highly tax-efficient. For sole traders, contributions reduce your taxable income; for limited companies, company contributions are Corporation Tax-deductible and don’t attract NICs. In 2025/26, you can contribute up to £60,000 annually (or your total earnings, if lower) with tax relief.

Reimbursing Expenses

Both sole traders and company directors can claim allowable business expenses (e.g., travel, equipment) to reduce taxable profits. For limited companies, ensure expenses are properly documented and reimbursed to avoid tax issues.

Keeping Cash for Corporation Tax

Limited companies pay Corporation Tax (19% or 25% depending on profits in 2025/26) on taxable profits. Avoid distributing all profits as dividends—set aside enough to cover this tax, due nine months after your financial year-end.

Conclusion

Paying yourself tax-efficiently requires careful planning, whether you’re a sole trader budgeting for Self Assessment or a company director balancing salary and dividends. Review your approach annually or when profits change, as tax rates, thresholds, and your business needs evolve. Small tweaks can yield big savings.

Want tailored advice? Book a free consultation with our experts to optimise your take-home pay and stay compliant.