What is a sole trader and how do I register as one? | unbiased.co.uk (2024)

Being a sole trader is often considered the simplest way of running a business – at least when the operation is a small one.

You have flexibility and full control over how you operate, but you’re also personally responsible for your business, which can be daunting and potentially very costly.

Sole traders don’t have to register with Companies House, but they do have to maintain accounting records, pay income tax and file a self-assessment return with HMRC every tax year.

For all the ins and outs of being a sole trader, read on.

Summary

• When you are both self-employed and the sole owner of your business, you’re considered a sole trader

• Sole traders need to pay income tax, as well as Class 2 and 4 National Insurance (NI) contributions

• There are advantages and disadvantages to being a sole trader

• To register as a sole trader you need to register with HMRC and complete annual self-assessments

What is a sole trader?

When you are both self-employed and the sole owner of your business, you’re considered a sole trader.

Sole traders have no shareholders or directors, unlike a limited company, and no other people responsible for liabilities, unlike a partnership.

You’re in full control of the business, overseeing its assets and benefitting from all profits after tax. This can be rewarding, but it also comes with a risk.

Sole traders have what’s known as unlimited liability, meaning if the business becomes insolvent or is sued, then you’re personally liable to creditors and must pay any damages yourself.

Sole traders are most commonly small businesses that provide a service to individuals and families.

They often have no or very few employees, and include the likes of photographers, plumbers, interior decorators, makeup artists or hairdressers.

What’s the difference between a sole trader and self-employed?

A sole trader is a self-employed person, but a self-employed person is not necessarily a sole trader. It all comes down to your business structure.

You’re a sole trader when you’re self-employed and the sole owner of your business.

If you’re self-employed, but are in a business partnership or run a limited company, you’re not a sole trader.

Most contractors operate as limited companies (either one-person companies or under an umbrella company), so even though they work alone and employ no one, their business is not a sole trader but a company.

What are the advantages of being a sole trader?

Being your own boss means you set the rules, so you have full control.

This allows for more flexibility, giving you the freedom to make quick decisions without the need for any board or shareholder approval, which is useful when you’re dealing one-on-one with clients.

There are other advantages to being a sole trader, including:

• Sole traders are quick to set up and have fewer statutory obligations
  You don’t have to register a company name or complete any Companies House forms, such as the annual confirmation statement. All you need to do is inform HMRC that you’re self-employed and operating as a sole trader, by registering for self-assessment. You can do this online or by post.

• Sole traders have an easier accounting job
  You don’t need to meet the same accounting standards as limited companies, which have to file corporation tax returns and annual accounts, including balance sheets. All you need to do is maintaina record of your invoices and expensesand senddetails of your profits in your annual self assessment tax return. Because of this, your accountant will charge you less than they charge a limited company.

• Sole traders can keep the profits
  Whilelimited companies have to divide profits between shareholders, you can keep everything you earn (after tax and deductions like wages, if you employ anyone). You also personally own all the assets used in the business.

• Sole traders can keep their financial information private
  As you don’t have to give any information to Companies House, there’s less publicly accessible information on you. This can give you a competitive advantagesince competitors can’t see how well (or badly!) you’re doing.

• Sole traders can change their minds as they grow
  It’s easy to move from being a sole trader to a limited company, but more tedious to do it the other way around. Sole trading can be a good place to start and test the business waters, giving you the option to change your mind if a limited company looks like a better option later on.

What are the disadvantages of being a sole trader?

Working outside of a company structure has its drawbacks. The buck stops with you, so you take all responsibility for big decisions.

Some sole traders also battle with striking a healthy work-life balance, since it’s hard to know when to take time off.

But more serious disadvantages include:

• Sole traders have personal liability (and unlimited liability)
  Sole trading businesses aren’t recognised as separate legal entities from their owners. This is perhaps the biggest drawback of being a sole trader. All the business debts and liabilities are yours. If you fail to pay off your business debts, you’ll need to pay the money owed from your own assets. This could even mean losing your home.

• Sole traders aren’t attractive to some clients
  Certain clients may be reluctant to work with a sole trader, either because they see them ashigher risk, orthey seem less prestigious. This depends on your industry and client type, so it’s worth doing your research before deciding what type of company to set up. In particular, if you are a freelancer/contractor, companies may be reluctant to hire you as you might appear to be an employee for tax purposes.

• Sole traders face tax planning limitations
  Although you can claim tax allowances on certain business expenses and assets, limited companies generally enjoy more tax benefits. When a good profit is made, for instance, limited companies pay less than their sole trader counterparts. Employed owners of limited companies can also draw dividends from their company, which carry a lower tax rate and give them more take-home pay.

• Sole traders risk a break in business continuity
  If you havea bad accident or fallseriously ill, the responsibility of fulfilling existing contracts still sits with you. This can be stressful, or result in debt if you’re unable to work. When setting up your business, it’s worth giving attention to these scenarios, planning around them and taking out business insurance where needed.

How do you register as a sole trader?

To register as a sole trader, you need to:

1. Contact HMRC. Let them know you’re self-employed and will be paying tax as a sole trader.

2. Complete the HMRC registration form for self-assessment, either online or by post.

3. Activate your HMRC online account. Once you’ve completed the registration form, HMRC will send you a 10-digit unique taxpayer reference and an activation code for your online account.

   See Also

   Tax issues for a home-based limited company

4. Complete your annual self-assessment tax returns, using the online account you set up.

There’s no need to register with Companies House as a sole trader.

How much tax does a sole trader pay?

Sole traders need to pay income tax, as well as Class 2 and 4 National Insurance (NI) contributions, on all taxable business profits.

Income tax

Sole traders that earn less than £100,000 in a tax year benefit from a personal allowance (or tax-free income), which for the 2023/24 tax year is £12,570.

If you earn over £100,000, this allowance decreases by £1 for every £2 of income over £100,000.

If you earn over £125,000, you don’t receive a personal allowance.

The amount of income tax you pay depends on your income after this personal allowance.

The following table is useful:

As an example, Remy is a plumber who made a £19,000 profit last year.

After subtracting his personal allowance, his taxable income is £6,430. This falls into the 20% band, meaning he pays £1,286in tax.

Class 2 and 4 NICs

If your business profit is over £6,725 in the 2023/24 tax year, you’ll need to pay Class 2 NI contributions, which is currently £3.45 a week or £179.40 a year.

If your profit is over £12,570 in the current tax year, you’ll also need to pay Class 4 NI contributions, which are calculated as a percentage of your total profits during your self assessment.

How do sole traders pay tax?

After completing your self-assessment return and calculating the tax you owe, you can pay HMRC using a debit card, credit card, online banking, CHAPS or by visiting your bank.

What expenses can you claim back as a sole trader?

Often, HMRC won’t tax you on money that you need to spend to keep your business running.

For this reason, when calculating your tax, you can deduct a range of operating expenses from your gross income.

You can view the full list of tax-deductible expenses here.

What accounts do sole traders need to keep?

Sole traders don’t need to submit as many accounts to HMRC as limited companies.

However, you do need to keep a detailed record of all your business income and expenses, which will be used during your tax return, including original invoices and receipts.

Do sole traders need a dedicated bank account?

Sole traders aren’t legally required to have a dedicated business bank account.

Because HMRC treats your personal and business income as one and the same, you can use your personal bank account for your business.

However, it is highly advisable to keep everything separate so that you don’t end up spending business funds on personal purchases, or vice versa.

Do sole traders need an accountant?

Accountants are a valuable support system for sole traders.

Although you don’t need to submit as many accounts as a limited company, an accountant can help you navigate your self-assessment tax form every year, keep track of invoices and expenses, and calculate how much tax you need to pay.

With personal allowances and tax deductibles, working out what you owe can get complicated.

Staying on top of your tax and accounts is particularly important for sole traders since you’re personally liable for any debts.

But accountants can also help you save money, making sure your business is as tax-efficient as possible.

Can I get sole trader insurance to protect me?

As a sole trader, you’re liable for any debts or damages incurred by the business, and at risk if you find yourself unable to work.

For these reasons, it’s worth taking out business insurance as a sole trader.

What you need depends on your business, but the four main types worth exploring include:

• Employer’s liability insurance
• Public and product liability insurance
• Professional indemnity insurance
• Buildings and contents insurance

When should I change from sole trader to limited company?

Being a sole trader is a good place for a new business to start. However, as your profits grow, you could lower your tax bill by becoming a limited company.

This will also give you limited liability (and better financial security), as well as greater borrowing power and more competitive credibility.

But you don’t have to become a limited company. Some people are happy staying sole traders.

If you think you’re ready to make the move, speak with your accountant about it.

They’ll assess whether your company is in a good financial place to set up as a limited company and offer you informed advice on the next steps.