In construction or the trades, probably the most important decision you’ll make when it comes to reducing your tax bill is how to structure the business. The two most common structures are sole trader and limited company.
Unfortunately, it isn’t always obvious which will be best for any given business. The fact is, you’ve got to really think it through and do the maths. Measure twice, cut once, as they say.
There’s pros and cons to both approaches – less paperwork and responsibility on the one hand, potentially less tax on the other.
Straightaway, I can hear people cutting in to go, “I’ll take the option with less tax, please!” Of course you will.
But it’s not as simple as that.
Read on and you’ll see what I’m getting at.
What’s the difference between a sole trader and a limited company?
You can skip this bit if you already know it but, in a nutshell:
- A sole trader is, say, a plasterer who trades under his own name – I’m going to call him Liam. Basically, Liam is the business. He sticks anything he earns into a bank account that’s also under his own name. At the end of the year, he does a personal tax return to report his taxable profit from the tax year, and that’s it.
- A limited company is ‘incorporated’ and trades under a registered name, like ‘Gallagher’s Plastering Ltd’. Liam is a company director and technically an employee of the business. It has its own business bank account and pays tax on any profits the company makes in its accounting period via an annual corporation tax return.
Keep it simple
The benefit of being a sole trader is that it’s dead simple to understand and dead easy to manage.
That’s why most tradesmen with their own businesses start out as sole traders – just because that’s the default, with no need to much at all.
Some people get over-excited and set up a company because they think that’s what you have to do when you start a business. But it can be total overkill if you’re a one-man band, with a van and no employees.
As a very rough rule of thumb, if you’re turning over less than about £30,000 a year, sole trader status will probably be OK.
Pros and cons
I touched on the downsides above: if you set up a company, you suddenly have a lot more responsibilities – and a lot more opportunities to cock it up and get the authorities breathing down your neck.
You’ve got to register with Companies House and HMRC. You need a business bank account. You have to complete a whole extra tax return. There are loads of records you have to keep and returns you need to file.
So why does anyone bother? The main reason is given away by that word ‘limited’.
If you’re a sole trader and your business gets in trouble, you could end up losing your house, your car and other personal assets. You are the business, simple as.
With a limited company, though, the business is responsible for the debt, not you personally, so your assets are probably safe.
Another important reason for going limited, though, is that overall, you’ll probably pay less tax over the long-term.
As a director, you can pay yourself a small salary topped up with dividends and pension contributions, steering clear of the higher-rate income tax bands.
You also pay corporation tax on your profits, at 19% in 2021/22, whereas sole traders might end up paying income tax at 40% if they make more than £50,270 in profit.
That can add up to a massive tax saving, meaning that all the additional responsibility is well worth it – especially if you leave all that to me.
We’ll work out which is best for you and give a clear recommendation – give us a call.