Profit Extraction Strategies for Owner-Managed Businesses in 2026/27

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The tax environment for profit extraction has shifted significantly following the Autumn 2024 Budget, with changes taking effect from April 2026 that will impact how owner-managed businesses extract value. Between frozen allowances, NIC thresholds, and increased dividend tax rates, the optimal strategy for extracting profits requires careful consideration - and in some cases, a fundamental rethink of business structure.

Contents

• The Tax Environment for 2026/27
• Sole Trader vs Limited Company
• Optimising Salary Levels for Owner-Directors
• Other Profit Extraction Methods
• Choosing the Right Strategy

The Tax Environment for 2026/27

The Autumn 2025 Budget introduced several changes that materially affect profit extraction planning, with most taking effect from 6 April 2026:

Personal Tax Thresholds

The personal allowance remains frozen at £12,570 until 5 April 2031, as do the basic rate band (up to £37,700), higher rate band (£37,701 - £125,140) and additional rate band (£125,140+). This extended freeze means fiscal drag continues to push more taxpayers into higher brackets as earnings increase with inflation.

Dividend Tax Rates

From 6 April 2026, dividend tax rates are set to increase as follows:

• Basic rate: 8.75% → 10.75% (+2%)
• Higher rate: 33.75% → 35.75% (+2%)
• Additional rate: remains at 39.35%

The dividend allowance remains unchanged at £500.

Class 1 National Insurance Contributions

The Class 1 primary threshold (employee NIC) and secondary threshold (employer NIC) are also frozen until 5 April 2031:

• Employee NIC: 8% on earnings between £12,570 and £50,270, then 2% above £50,270
• Employer NIC: 15% on earnings above £5,000

The Class 1 Lower Earnings Limit (LEL) will increase to £6,708 for 2026/27. Directors and employees must earn at least this amount to maintain their entitlement to state benefits, including qualifying years for the state pension. Those earning below this level may need to plug gaps in their contribution record by paying Class 3 voluntary contributions (£18.40 per week in 2026/27, totalling £956.80 for the year).

Sole Trader vs Limited Company

For anyone starting a new business, or considering whether to maintain their current structure, the fundamental question remains: should you trade as an unincorporated sole trader or through a limited company?

This decision involves numerous commercial, legal, and practical considerations, but the tax efficiency of each structure is often a primary concern. Using a simplified model that assumes all post-tax profit in a company is paid as dividends, we can compare the post-tax income available to the owner under different structures and salary levels.

Comparative Analysis

The table below shows post-tax income at various profit levels, comparing:

• Sole Trader: profits taxed as trading income subject to income tax and Class 4 NIC
• Company (PA, no EA): company with one director taking a personal allowance level salary (£12,570) with no Employment Allowance available
• Company (LEL): company with one director taking a Lower Earnings Limit salary (£6,708)
• Company (PA & EA): company with one director taking a personal allowance level salary where Employment Allowance is available

Profit	Sole Trader	Company (PA, no EA)	Company (LEL)	Company (PA & EA)
£30,000	£25,468	£24,403	£24,045	£25,224
£50,000	£40,268	£38,862	£38,504	£39,683
£80,000	£57,711	£55,765	£55,182	£56,301
£100,000	£69,311	£65,209	£64,627	£65,746
£150,000	£92,040	£85,110	£85,273	£85,458
£200,000	£118,450	£105,765	£105,757	£106,271

What the Numbers Tell Us

The results may surprise many business owners: when comparing like-for-like tax positions and ignoring the ability to retain profits in a company for future extraction via dividends or liquidation, running an unincorporated business is generally more tax-efficient than operating through a limited company.

This conclusion holds across most profit levels, with an unincorporated business structure delivering higher post-tax income than most of the above company scenarios. The gap narrows at certain profit levels - particularly around £60,000 where a company eligible for the Employment Allowance nearly matches the sole trader position - but overall, the unincorporated route typically wins on pure tax efficiency.

Why is this the case?

The primary reasons are:

1. Lower NIC rates for the self-employed: Class 4 NIC is charged at 6% on profits between £12,570 and £50,270, then 2% above £50,270. This compares favourably to the combined employee and employer NIC burden in a company (8% or 2% employee plus 15% employer).
2. Double taxation in companies: Company profits are first subject to Corporation Tax (19% for small profits, up to 26.5% marginal rate in the taper thresholds, then 25% above £250,000), and then dividends paid from post-tax profits are subject to personal income tax in the hands of the individual. This two-stage taxation can create a higher overall burden than the single layer of income tax and NIC faced by unincorporated traders.
3. Increased dividend tax rates: The 2% increase in dividend tax rates from April 2026 widens the gap further, making the company structure less attractive from a pure tax perspective.

Important Caveats and Considerations

While the tax analysis points clearly toward unincorporated trading, this conclusion necessarily simplifies a complex decision. As detailed below, there are other important factors that should be considered when deciding whether to trade via a limited company structure.

Additional Running Costs

Operating a limited company involves additional compliance costs that sole traders do not face, including Companies House fees, statutory accounts preparation and filing, and Corporation Tax return preparation. Depending on the quality of record-keeping and business complexity, these additional costs could easily range from £1,500 to £5,000 plus VAT annually. When factored into the comparison, the tax disadvantage of a company structure becomes even more pronounced.

Commercial and Legal Considerations

Tax efficiency is only one factor in the decision whether to incorporate. Companies offer several important non-tax advantages:

• Limited liability protection: Shareholders' personal assets are generally protected from business liabilities
• Credibility and perception: Some clients and suppliers prefer dealing with limited companies
• Succession and exit planning: Company ownership can be more easily sold or transferred
• Employee incentives: Share schemes and other equity-based incentives are easier to implement

For many business owners, these factors may outweigh any additional tax or running costs associated with incorporation.

Capital Retention and Extraction

The analysis above assumes all post-tax profits (after salary) are immediately extracted as dividends. In practice, many company owners retain significant profits in the business, either for reinvestment or to extract later at more favourable capital gains tax rates (18% or 24%, compared to dividend tax at 35.75% or 39.35%). If you can afford to retain profits in a company and later extract them on liquidation or as part of a company sale, the effective tax cost may be considerably lower than the above simplified model, making a company structure more comparable with - or even superior to - an unincorporated business.

Practical Realities

For businesses already trading via a limited company, disincorporation is rarely straightforward. Unwinding a corporate structure may crystallise significant ‘dry’ tax charges, resulting from the transfer of the company’s assets/liabilities to the ultimate owners. Where a company structure already exists, it's usually retained unless there are compelling commercial reasons to change.

The Verdict

For new businesses where limited liability and other commercial factors are not pressing concerns, and where profits will be fully extracted annually, trading as an unincorporated business often delivers a higher post-tax net income. However, the decision should never be made on tax grounds alone, and the ability to retain and accumulate profits in a company for later extraction at beneficial tax rates can fundamentally change the analysis.

Optimising Salary Levels for Owner-Directors

If you're already trading through a limited company, the key question becomes: what level of salary should the owner-director take?

The conventional wisdom has long been to take a salary up to the personal allowance (currently £12,570) to fully utilise this tax-free amount while maintaining state pension entitlement. But is this still the optimal approach for 2026/27?

Personal Allowance vs Lower Earnings Limit

For companies with a single director and no other employees, there are two common salary strategies:

1. Salary up to Lower Earnings Limit (£6,708 for 2026/27): this is the minimum salary required to secure state pension credits and has a lower exposure to employer NIC
2. Salary up to Personal Allowance (£12,570 for 2026/27): fully utilises the tax-free personal allowance (if available), while creating additional Corporation Tax relief

Based on the above simplified model, after factoring in the Corporation Tax relief on the additional salary and the corresponding reduction in dividends, a salary set at the personal allowance nearly always delivers higher post-tax income.

If the company is already incorporated and disincorporation is not feasible (see above), taking a salary of £12,570 is nearly always preferable to a salary of £6,708, assuming the company has sufficient taxable profits to benefit from the associated Corporation Tax relief.

Should You Take a Salary Above the Personal Allowance?

Given that employee NIC on amounts above the personal allowance is relatively modest at 8%, could it make sense to take a higher salary? The short answer is: in most cases, taking a salary above the Personal Allowance will reduce post-tax income.

To illustrate this clearly, consider a company with profits of £80,000 before director's salary:

Salary Level	Post-Tax Income to Director
£12,570 (PA)	£55,765
£20,000	£55,222
£30,000	£54,311
£50,000	£51,716

As highlighted in the above table, taking a salary above the personal allowance will typically reduce overall post-tax income when the remaining profits are fully extracted as dividends.

Therefore, for most sole-director companies without other employees (and therefore unable to claim Employment Allowance), it will likely be beneficial to structure your core profit extraction strategy as follows:

• Take a salary of £12,570 to utilise the personal allowance, maintain state pension entitlement and reduce the company’s annual corporation tax liability
• Extract further profits as dividends, subject to distributable profits, business cash flow and personal income requirements

Other Profit Extraction Methods

While salary and dividends form the core of most profit extraction strategies, there are several alternative approaches that can deliver material tax savings in the right circumstances.

Interest

Where a director lends money to their company - either via a formal loan agreement or director’s loan account - they can charge interest on this credit balance at a commercial market rate.

How it works:

• The company is charged interest periodically
• The interest is deductible for Corporation Tax purposes, saving tax at 19%, 25%, or 26.5%
• The director receives the interest (net of withholding tax – see below) and reports it as savings income on their personal tax return

Personal tax treatment:

Interest income benefits from two valuable reliefs:

The Starting Rate Band for Savings (£5,000): If a director's taxable non-savings and property income (after the personal allowance) is below £5,000, they may benefit from a 0% tax rate on up to £5,000 of savings income. For a director taking only a personal allowance level salary (£12,570) and no other income, this means up to £5,000 of interest could be received tax-free.

The Personal Savings Allowance: In addition to the starting rate band, eligible taxpayers may benefit from the Personal Savings Allowance (PSA) of £1,000 for basic rate taxpayers and £500 for higher rate taxpayers (N/A for additional rate taxpayers). Interest income covered by the PSA is taxed at 0%.

Effective tax saving:

Consider a director taking a personal allowance salary who is a basic rate taxpayer with no other interest income. If they charge £6,000 interest to the company and the company’s marginal Corporation Tax rate is 25%:

• Corporation Tax saved by company: £1,500 (25% of £6,000)
• Personal tax paid by director: £0 (£5,000 covered by starting rate band, £1,000 by Personal Savings Allowance, with any tax withheld via CT61 reclaimable through Self Assessment)
• Net tax saving: £1,500

This represents a substantial reduction in tax leakage compared to extracting the same £6,000 as a dividend (which would attract 10.75% personal income tax = £645, with no Corporation Tax relief).

One practical point to note: if a UK company pays interest to an individual, it must deduct and withhold 20% income tax at source, reporting it to HMRC via Form CT61 accordingly. The tax withheld at source may then be offset against the individual’s actual income tax liability for the year, once calculated.

Employer Pension Contributions

Making employer pension contributions on behalf of directors remains one of the most tax-efficient ways to extract value from a company:

• Tax-deductible for the company: Saving Corporation Tax at 19%, 25%, or 26.5%
• Tax-free for the director: No personal tax due, provided total pension contributions do not exceed the available annual allowance (see below)
• Tax-free growth: Investments within the pension grow free of income tax and capital gains tax
• 25% tax-free lump sum: may be taken on retirement - 25% of your pension pot, up to a maximum across all your arrangements of £268,275

However, with regard to employer pension contributions, care must be taken not to exceed the annual allowance for pensions (currently £60,000), which tapers down for ‘high income individuals’.

While employer pension contributions are highly tax-efficient, owner-managers may be reluctant to use this route if they are not close to pension age, as the benefit can feel abstract and distant.

Trivial Benefits

The trivial benefits exemption allows employers to provide small benefits to employees and directors without triggering a tax or NIC charge, subject to various conditions:

• The cost of providing the benefit is £50 or less (including VAT)
• The benefit is not cash or a cash voucher (though non-cash vouchers such as Amazon vouchers are permitted)
• The benefit cannot be provided as part of a contractual obligation or in recognition of particular services carried out by the employee
• For directors of close companies, there is an annual cap of £300 on trivial benefits

Common examples include sending flowers to an employee on an event such as a birthday or birth of a child, provision of a present at Christmas, and seasonal flu jabs.

The Liquidation Alternative

Rather than extracting all available post-tax profits annually as dividends, owner-managers with a long-term view should consider whether retaining profits in the company could lead to more tax-efficient extraction in the future

Capital distributions via liquidation are subject to Capital Gains Tax (CGT) rather than income tax, with rates from April 2026 as follows:

• 18% for basic rate taxpayers
• 24% for higher and additional rate taxpayers
• 18% if BADR applies (subject to a £1 million lifetime limit)

In addition, the first £3,000 of capital gains (the Annual Exempt Amount) may be tax-free.

This strategy may be particularly favourable for higher or additional rate taxpayers and those eligible for Business Asset Disposal Relief (BADR). However, the gap between income extractions and capital distributions has narrowed. Recent increases in CGT rates, a less favourable BADR regime, and the reduction of the Annual Exempt Amount (AEA) mean that capital treatment is not always the most tax-efficient option.

In fact, where profits are extracted within the basic rate band and the AEA has already been used, income distributions (dividends) may result in a lower overall effective tax cost. As ever, the most efficient strategy will depend on the individual's full tax position, profit levels, and timing of extraction.

For companies with distributable reserves below £25,000, an informal striking off procedure can be used instead of a formal liquidation, avoiding liquidator costs while still achieving capital treatment.

This strategy typically makes sense where the director is a higher or additional rate taxpayer, the company has accumulated substantial reserves, the business is genuinely being wound up, and the director does not need immediate access to all retained profits for living expenses.

Choosing the Right Strategy

Based on the analysis above, the following general principles emerge:

1. For new businesses, remaining unincorporated is often more tax-efficient if profits will be fully extracted annually and limited liability protection is not essential. However, incorporation may still be justified for commercial, legal, or succession planning reasons.
2. For owner-managers of existing companies, taking a salary up the personal allowance (£12,570) will be optimal in most cases, unless specific circumstances justify a different approach.
3. Consider declaring dividends before 6 April 2026, if funds will be required in the near future, to benefit from the current (lower) dividend tax rates. However, consideration should be given to any impact on personal marginal tax rates.
4. Review alternative extraction methods based on your personal circumstances. This could include interest on director's loan balances, pension contributions, or retaining profits for future capital extraction if you're planning a future exit.

Taking the time to plan your profit extraction strategy, and reviewing it periodically as circumstances change, can deliver significant tax savings and ensure your approach remains aligned with your personal and business goals.

Get in Touch

We work with owner-managed businesses to develop tax-efficient, commercially sound profit extraction strategies tailored to individual circumstances. Whether you're deciding on business structure, optimising your remuneration mix, or planning a future exit, we can help you understand your options and avoid common pitfalls

If you'd like tailored advice on the most effective way to extract profits from your business, contact us today to arrange a free initial consultation.

This article provides general information and should not be considered professional advice. It reflects legislation and practices at the time of writing, which may change. Individual circumstances vary, so please consult us before taking any action. We accept no responsibility for financial loss arising from actions taken without our written advice.

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AUTHOR

Liam O'Riordan

As Principal at Veritas ATS, I help start-ups, owner-managed businesses, and individuals simplify accounting and tax, providing clear, practical solutions tailored to their needs.

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