A sole trader is a self-employed individual who owns and runs their own business as an individual and, as their business isn’t a separate legal entity to its owner, a sole trader is their business.
Being a sole trader means you have complete control over your business, all its assets and any profits after tax. As well as giving you total control, this business model has several advantages including being relatively straightforward and versatile.
However, unlike owners of limited companies, sole traders are personally liable for all their business’ debts your personal assets could be at risk if you are unable to pay your creditors. This unlimited liability for events that occur while operating your business and the pressure involved in you having to bear the brunt of all the responsibility can present you with several significant challenges.
Therefore, while the definition of a ‘sole trader’ is often used instead of ‘self-employed’ when describing this type of business model, be careful as the terms do have slightly different meanings.
Characteristics of a sole trader
A main feature of being a sole trader is that you will work alone, and your business is entirely owned and managed by you with no separation between the management and the ownership of your business.
If you are a sole trader, you do not need to file accounts or any other documents with Companies House, but you must register with HM Revenue and Customs (HMRC) as soon as possible after starting your business. As a sole trader, you will pay income tax (not Corporation Tax) on your business’ profits and pay National Insurance Contributions (NICs). You will also be required by HMRC to complete and submit a Self-assessment Tax Return every year. And depending on your business’ turnover, you may also need to register it for VAT.
Quite often, a sole trader will often operate through a personal service company set up to act as an intermediary between themselves and their clients or customers. There are special tax/NIC anti-avoidance rules, such as the IR35 regulations, which apply in such cases if the ‘intermediary’ is a tax driven device.
What’s the difference between ‘sole trader’ and ‘self-employed’?
A sole trader is always self-employed for tax purposes, but not everyone who is self-employed is a sole trader. Self-employed means that you are not employed by someone or that you pay tax through Pay As You Earn (PAYE). Most self-employed individuals run businesses that use the sole trader structure, but they could also be part of a partnership or be a director in a limited company.
What are examples of sole traders?
The sole trader structure is the one most used, but not exclusively, within the services sector. An example of a sole trader may include:
- Decorators and Plasterers
- Personal Tutors
- Freelance writers
- Fitness instructors
Can a sole trader employ staff?
It is a common misconception that sole traders cannot employ staff and while it is true that sole traders operate and own their businesses, they can in fact employ casual, part-time or full-time staff to carry out work for them. However, if as a sole trader you do employ staff, you will be responsible for collecting income tax and NICs from them and paying these to HMRC. Therefore, you will need to operate a PAYE payroll scheme to do this.
Legal obligations and responsibilities of a sole trader
Setting up your own business as a sole trader may be the most straightforward option for a new start-up but you will still have to meet several sole trader responsibilities and legal obligations.
You will need to file a Self Assessment Return
As a sole trader, you need to file a Self Assessment Tax Return at the end of the financial year (5th April). Your income tax is calculated based on the profits you have filed. You need to pay the bill by 31st January of the next year.
Filling your tax return means you need to submit records of your sales and expenses, as well as receipts and other relevant records, so keeping on top of your bookkeeping is vital which can be done using online software such as QuickBooks, Xero and Dext.
You will have to make National Insurance contributions
As a sole trader, you will need to make two National Insurance contributions: Class 2 and Class 4.
Class 4 National Insurance will be automatically calculated once a year as a percentage of your profits and be automatically included within your taxes when you complete your Self-assessment Tax Return.
Class 2 National Insurance is a flat-rate contribution that is calculated on a weekly basis. Even though the amount is relatively small, it is important to register for Class 2, or you will be asked to pay for it all in a lump-sum at a future date.
It is also important to register for Class 2 National Insurance so that you will qualify for state benefits. You can usually pay your Class 2 National Insurance through your Self-Assessment.
You may need to register for VAT
Registering for VAT is optional if your turnover is up to £85,000, however if you exceed this threshold, you will need to be VAT registered.
If you do register for VAT, you will need to complete VAT returns and keep your bookkeeping records up to date. You can register for VAT online to receive your VAT number and you will get an online VAT account through which you can filet your VAT returns.
However, if you intend to carry out business with other businesses but your turnover is under the £85,000 threshold, registering for VAT may still be advisable. It will enable you to claim back the VAT on your work-related purchases and pass on the VAT you will be charging to your clients, without having to increase the price of your own products or services.
It may also be worth bearing in mind that quite a few people perceive VAT-registered businesses as being more trustworthy than those that are not.
You will have to register for PAYE if you employ staff
As mentioned earlier, as a sole trader, you can employ staff to help you in your business. You will need to decide whether you want full-time or part-time workers or may prefer the flexibility of working with freelancers.
Should you opt to have staff on your payroll, you are legally required to register for PAYE to collect Income Tax and NICs from your workers, which you will then pay to HMRC. You will need to register online for a PAYE reference number and be required to set up an employer’s workplace pension scheme.
Bear in mind that if you do opt for employing staff your business will need to generate enough to pay them monthly. If you choose to look after PAYE on your own, you may need to subscribe to an online bookkeeping service that also offers payroll services.
And as an employer, you are legally bound to pay your staff the minimum wage at the very least.
Having staff working on your premises will also mean you will need to get employers’ liability cover, which you will have to pay for. In addition, you will face other legal requirements if you have employees including pension payments, holiday, and maternity leave, and ensuring your workplace is safe.
Need help setting up as a sole trader?
So, there are lots of factors to consider before you choose to become a sole trader. Most people starting in business will begin as a sole trader and then incorporate into a limited company once they have reached a certain size. However, this decision is as unique as you are, so you are best to speak to an accountant who can tell you what would be best suited for you and your business.
Here at TaxAssist Accountants, we can help you understand what being a sole trader means and help you decide if this is best structure for your business. We can also show you how other business models may change your tax position. If you like to discuss becoming a sole trader, please call us today on 01925 368 999 for a free no obligation consultation, or fill in our online form here.
Date published 20 May 2020 | Last updated 8 Jun 2021This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayer’s circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.