Being self-employed or working as a freelancer can be rewarding, but it’s important to set yourself up correctly. Here are the ins and outs of sole trader registration, tax and accounts, as well as the difference between a limited company and a sole trader.
What is a sole trader?
A sole trader is someone who works for themselves. There’s no separation between them and the business, which they fully own and run. It’s the official name for being self-employed or having a sole proprietorship. If you’re freelancing or running a business that you haven’t registered with Companies House, you’re operating as a sole trader. All that’s required is for you to register as self-employed with HMRC.
When you’re a sole trader, all your income is classified as personal income. You’re personally responsible for all losses, bills, record keeping and spending. After you’ve paid tax, you can keep all your profits.
How to register as a sole trader
Setting up as a sole trader isn’t difficult. All you’ll need to do is register on HMRCs website for a Self Assessment tax return.
You’ll also need to pick a name for your business. You can trade under your own name or pick a different one to use. You don’t need to register your name, just be sure not to use another business’s name or make any reference to a limited company (by using terms like Ltd, LLP, plc or limited).
Sole trader tax
As a sole trader, you’ll submit a Self Assessment tax return to HMRC each year. You’ll need to keep records of all your income and expenses to work out your profit or loss for your tax return. You will need to submit these if HMRC asks to see your records.
Be sure to keep all your receipts, invoices and bank slips for at least five years.
For the current sole trader tax rates, check HMRC’s Income Tax rates and bands.
You only have to register for VAT if your business turnover is over £85,000 in any 12-month rolling period. There are some situations where you may want to register despite not meeting this threshold, like if you want to reclaim VAT from selling to VAT-registered companies.
Sole trader vs. limited company
One of the key differences between a sole trader and a limited company is that when you’re a sole trader, you’re completely responsible for your business. You hold full personal liability should you owe money or lose money. There’s no distinction between personal money and your business’s money.
With a limited company, your liability is limited to the money you put into the business. This makes it less risky to operate.
The other major difference is how your taxes work. As a sole trader you’ll need to file a Self Assessment tax return. When you have a limited company, you’ll need to file annual accounts with Companies House and pay Corporation Tax on your profits, in addition to your Self Assessment tax return.
A limited company involves significantly more paperwork than a sole trader, but you could benefit from limited liability and better tax efficiency.
You’ll need to weigh up the pros and cons to decide if becoming a sole trader is right for you.
Advantages and disadvantages of becoming a sole trader
- It’s very easy to get started
- There are zero setup costs
- You won’t have a lot of paperwork
- You don’t need to register with Companies House
- Accounting costs are lower
- All profits are yours, after tax
- You can change your business structure easily
- Unlimited liability, you’re personally responsible for debts
- Often less tax efficient than a company
- Difficult to raise funds
- Less “prestige” than a company
Sole trader insurance
Sole traders can take out both public liability insurance and professional indemnity insurance. Both forms of cover protect you from the risks of doing business, such as if a client claims you’ve lost them money (professional indemnity) or if someone gets hurt as a result of your services (public liability).
In many cases you’ll be required to have insurance as part of your contract with another business. If you’re in an industry likely to need some form of insurance to mitigate any risks, it’s probably a good idea to take some form of cover.
Sole trader contractors
It’s rare to find contractors who’ve chosen to set up as a sole trader. They usually opt for a limited company structure. This is because it’s difficult to find work as a contractor if you’re a sole trader.
Contractor recruiters and businesses will often require you to work through a company structure to prevent you being seen as an employee of the company. If you could be legally viewed as working for the company, the company could be held liable for tax issues and you could technically claim employment rights from them.
Other considerations of becoming a sole trader
Sole traders can employ staff
To take on employees, you’ll need to register as an employer with HMRC and sign up for employers’ liability insurance. You’ll also have to operate a PAYE scheme, deducting tax and National Insurance for your employees.
Sole traders need to keep all their records
Keep all your receipts, bills, invoices and details of all the sales and expenses you make. You’ll need these when filling out your tax returns.
These are the sole trader tax deadlines
The Self Assessment tax deadline is on 31 January each year. You need to file your tax return for the previous tax years’ income before 31 January. The tax year runs between 6 April and the following 5 April each year.
You’ll also need to prepare for “payments on account”. These are twice-yearly advance payments to HMRC of 50% of your previous tax bill each. The deadlines for your payment on account are 31 January and 31 July.
We’d recommend doing all your accounting and tax return filing online. This will keep you remain completely compliant with HMRC’s Making Tax Digital initiative.
Sole traders can set up partnerships
A partnership is similar to operating as a sole trader except that there are two or more people involved in the business. You share responsibility for the business, so your personal liability for any losses or expenses is reduced.
Partners all share the profits of your business, and each person pays tax on their respective profits.
You’ll need to select a “nominated partner” who will keep business records and file the partnership’s tax returns. Other than that, each partner will still need to fill out their own Self Assessment tax return with HMRC.
Sole traders can become companies
You can move from being a sole trader to a limited company. This could be because your business has grown and you want to take on bigger projects, or because you want to limit your personal liability.
Have you got any unanswered questions about becoming a sole trader? Let us know in the comments.
We provide accounting, tax and financial management services tailored to your business. For help with business setup, Self Assessment returns, tax refunds and more, get in touch with our experts by emailing email@example.com or calling +44 (0) 20 7759 7553.
We are a professional services company that specialises in cross-border financial and immigration advice and solutions.
Our teams in the UK, South Africa and Australia can ensure that when you decide to move overseas, invest offshore or expand your business internationally, you'll do so with the backing of experienced local experts.