With many individuals starting a ‘side hustle’ to boost their income, setting up as a sole trader or limited company is the first main decision.
Whether this is selling books on Amazon or re-selling cars on eBay, any gross income over the £1,000 casual trading allowance requires a Self Assessment tax return.
While both structures can work well, the best choice depends on an individual’s current Income Tax and whether they need immediate access to profits.
What are the tax implications of being a sole trader?
When you are a sole trader, any profit from your side hustle is piled on top of your main employment income.
This means HMRC puts both income streams into the same pot to calculate your Income Tax.
For those working full time, their personal allowance has likely already been eaten by their salary, so any pound of profit earned as a sole trader is taxed at their marginal rate.
Let’s work through an example. Imagine you earned £40,000 from full-time employment and your side hustle raked in £12,000 profit – this would make your total annual income £52,000.
As the side hustle income is added on top of the £40,000 salary, most of it will be charged at the marginal 20 per cent tax rate, while some will teeter into the higher 40 per cent band.
You’d pay £2,746 in Income Tax from the side hustle, according to the 2026/27 rates.
If you have a student loan, repayments might increase if your additional earnings push you over the threshold.
Are limited companies more tax efficient?
Where sole trader profits are treated as an addition to a salary, a limited company side hustle would pay 19 per cent tax on small profits under £50,000, according to the 2026/27 rates.
Using the same example, the corporation tax bill for the side hustle would amount to £2,280.
While this might seem more appealing, tax problems bite when trying to extract the profits.
The most common method to transfer side hustle income into a personal bank account is via dividends, for a director of a limited company.
If all profits were to be extracted immediately, the overall tax position can sour, which might mae it worse than operating as a sole trader.
The first £500 extracted via dividends is entirely tax-free, but anything over this is taxed.
Current UK dividend tax rates are 10.75 per cent basic rate, 35.75 per cent higher rate and a 39.35 per cent additional rate.
If the side hustle owner was to withdraw profits as they are earned, total tax liabilities would total £3,271.15, which would mean paying £525.15 more in tax than a sole trader would.
Sole trader vs limited company: Which should I choose?
Looking at both examples, you might assume that the sole trader structure is the clear winner, but this isn’t always the case.
These two examples assume you are going to extract all the profits from your side hustle straight away, rather than leave capital in the business to reinvest.
The structural advantage of a limited company is that you do not have to take all profits as dividends and you can control the timing of extraction.
When profit is retained and reinvested in a limited company, the outlook changes.
Dividends can be paid flexibly to make them more cost-effective, for example when you’ve switched to part-time and or dropped into a favourable dividend tax banding.
As many side hustles look to scale aggressively, this can make a real difference, especially where an individual’s lifestyle is already covered by their full-time income.
For those wishing to spend the money as it is earned, the advantage largely disappears and a sole trader structure would perhaps work better.
Speaking to an accountant
Choosing between a limited company or sole trader structure is rarely straightforward.
Our accountants will consider your whole financial picture, weighing up which structure is right for your situation and where tax liabilities could be saved.
Whether you want to use your profits as a salary supplement or scale your business to replace your current job, we can plan how and when to take money out of your company.
For people juggling full-time work and a side hustle, schedules are likely to be at maximum capacity, so outsourcing your admin to an accountant can help free up your precious time.
Speak to our accountants for advice on how to grow your side hustle and optimise tax structures.
