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Should I set my trade business up as a sole trader or limited company?

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Can’t decide between operating as a Ltd company or a sole trader? In this guide, we break down the differences to help you make the best choice for you, your business and your future...

A limited company is a separate legal entity that can own property and other assets, run up debts and be sued.

As a sole trader, you are the business. Your personal and professional finances are intertwined.

Here’s what the differences are on a day-to-day basis.

Personal protection

One of the crucial differences between a Ltd company and a sole trader is the concept of limited liability. Here’s how it works:

  • Limited liability - If a Ltd company fails, the owners can’t be held responsible for any of the debts it’s built up. It’s called limited liability because you as a director don’t need to use your personal assets to cover the debt. A liquidated company will not count against your personal credit score.
  • Single entity - As a sole trader, your assets and business assets are legally treated as being the same. So, if your business runs up debts or goes bust, your personal assets are at risk.

From a purely legal standpoint, operating a Ltd company is the safest approach to take. However, that’s offset with the increased costs, complexity and responsibility of running a Ltd company.

Also, there are specific small business insurance policies that you can buy as a sole trader that can reduce or remove your personal risk.

Realistically, if you run your business properly and professionally, the risk of making substantial losses or finding yourself facing legal problems is low.

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Take home pay

As a sole trader and a Ltd company director, you can offset your essential expenses on things like tools, your van and even work clothing against your profits. This reduces the total tax you pay.

However, there are some slight differences in your take home pay that you should be aware of:

  • Sole traders pay tax on all profits above the tax-free threshold (£12,500 for 2020/21).
  • Accountants recommend that Ltd company directors take low pay from the business, and supplement it with dividends taken from profits. Doing it this way means you pay a little less tax (although the Government is reducing the difference).

While you may pay slightly less tax with a mixture of pay and dividends through a Ltd company, you have greater responsibilities and higher ongoing business costs.

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Ongoing expenses

As a sole trader, you can keep your business lean. If you can manage basic bookkeeping, are happy to keep records and are confident with a calculator there’s no reason why you can’t manage your own tax affairs yourself.

The legal requirements around running a limited company mean that you’re going to incur costs that could affect the bottom line. You must instruct a qualified accountant.

On top of this, you’ll need to file certain forms on time. Fail to do so, and you can be hit with hefty fines. Additionally, you’ll need a separate business bank account. You can’t use your personal account.

If you earn over the VAT threshold, you’ll also need to invest in accounting software for Making Tax Digital. This will cost around £25 per month.

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Good to grow

As a sole trader, you are the business. A Ltd company can grow to any size, and develop over time, with the appointment of other directors and staff. A Ltd company structure is also better for employing other people too.

One of the key reasons people choose to start a Ltd company is the belief that it’s somehow more trustworthy and transparent, and looks more professional to your clients.

Over time you can establish your business, build up a reputation and create contacts. You may find that other businesses are more willing to engage with a business, rather than an individual.

Finally, if you ever decide you want to sell your business, then a Ltd company structure is essential.

Both avenues are perfectly good ways to run a business and work for tradespeople across the country - do your research to see what seems right for you.

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