Setting up a trades business is an exciting step, whether you’re a plumber, electrician, builder, or any other hands-on professional. But before you start dreaming of logoed vans and steady clients, there’s a key decision to make: will you operate as a sole trader or set up a limited company? This choice isn’t just about paperwork. It can impact your taxes, liabilities, and potential customers’ views of your business. In this article, we’ll break it down in our usual jargon-free way.
Setting up a Trades Business – Sole Trader or Limited Company:
Who owns the cash in the bank?
Sole Trader: You do. Anything the business owns, including cash in the bank and equipment, is yours to use as you wish. However, any business debts are also yours!
Limited Company: The company owns everything, even if you’re the only director. That also means that you’re not personally liable for debts that the business owes. It’s important not to treat the business’s bank account as if it’s an extension of your own.
Paperwork Priorities:
Sole Trader: You need to submit a self-assessment tax return every year. This covers all of your personal income, including any from employment, self-employment, or property. You have until the end of the January after the tax year. So, for the tax year that ended 6th April 2024, you have until 31st January 2025 to submit your return and pay any tax due.
Limited Company: Your paperwork requirements are a bit more involved. As well as a personal self-assessment return, you must submit annual accounts, a company tax return, and a confirmation statement. If you choose to pay yourself a salary, you must register as an employer and run payroll. You’re not required to have one by law, but many people choose to work with a bookkeeper or other accounting professional to help them with all of this. That’s where we come in!
Profits & Pay:
Sole Trader: we always recommend having a separate bank account for the business. However, you have full access to any money the business has, and there’s nothing stopping you from taking money directly from this for your personal use.
As good practice, we recommend treating withdrawals like a salary and transferring money over once a month, making it easier to manage. Any money you take from the business is known as drawings. You don’t need to register as an employer with HMRC or declare this as income.
Limited Company: You can’t use the company’s bank account as your personal funds. When you take income from the company it must be as salary, dividends or a combination of both.
How you choose to take money from the company depends on personal circumstances. However, many directors will take a nominal salary and top this up with dividends. If you’re taking a salary, you must register as an employer with HMRC (even if it’s just you). Dividends are a distribution of any profit after corporation tax, so you need to be careful that you don’t take more than is available. Again, this is an area where it’s best to speak to a professional about what would be best for you.
Tax Tips:
Sole Trader: As there’s no distinction between you and the business, your profits are treated as income and taxed as such. Even if you don’t physically take the money out of the bank account, you are liable for tax on all the profits. However, you get your normal personal tax allowance (£12,570 for 2024-25), so only pay tax on your income above this amount. Tax is calculated using the normal personal tax bands of 20%, 40% and 45%.
Limited Company: The company pays tax on profit at 19% on profits under £50k and 25% on anything over £50k. Companies have no tax allowance, so this applies from the first £1 of profit. You’ll also personally pay tax on any income you receive from the company. Tax on dividends is calculated at a lower rate than other personal income, which means that it can be more tax-efficient to take income this way.
National Insurance Know-How:
Sole Trader: You pay Class 4 NI, depending on your profits. If your profits are £6,725 or more, your Class 2 contributions are treated as having been paid to protect your national insurance record.
Limited Company: You pay Class 1NI, the standard rate through your payroll. It’s 8% on earnings between £242 and £967 weekly and 2% on anything over that. If you earn less than £242 a week, you can pay NI voluntarily to ensure there are no gaps in your National Insurance record. That one is Class 3 NI.
VAT Verdict:
Sole traders and limited companies have the same VAT rules. If a business earns over the £85,000 VAT threshold (in any rolling 12-month period), it must register for VAT and charge VAT on products and services.
Asset Allocation:
Sole Trader: You own your business and everything in it, including the assets. That means you are personally liable for all business debts and obligations, and your personal assets could be at risk if the business encounters financial difficulties.
Limited Company: A limited company is a separate legal entity from its owner(s), so the company owns the assets, not the owner/shareholders. As such, you have limited liability, which protects your personal assets from any business debts. However, watch out for personal guarantees as they make you personally liable.
If you’re setting up a trades business or even operating already and need advice about business structure, talk to us.