What is a Sole Trader?
A sole trader is the individual owner of a business which, unlike a limited company, is not legally distinct from its owner. It means that a sole trader is entitled to keep any after-tax profits they make, but also that they’re personally responsible for any debts.
A sole trader business (or being self-employed as its commonly known) is the simplest type of business, as it’s the easiest to set up and run.
Operating as a sole trader:
As a sole trader, you’ll be:
- Personally responsible for any losses your business makes
- Personally responsible for any of your business’ bills
- Personally responsible for keeping accurate records of your business’ sales and spending.
The business will be set up under your name and you are entitled to keep all of the profits.
But this means you are also responsible for the tax owed, along with any debts incurred by the business. In essence, as a sole trader, you are the business.
Paying taxes as a sole trader
A sole trader needs to do the following things:
- Send a Self-Assessment tax return every year
- Keep a record of all income and expenses
- Pay Income Tax based on your taxable income
- Pay Class 2 National Insurance Contributions (NICs) at a fixed rate of £3.05 per week in the 2020/21 tax year (unless your annual profits are less than £6,475)
- Pay Class 4 National Insurance Contributions (NICs). In the 2020/21 tax year, these are 9% of profits between £9,500 and £50,000 and 2% on profits above £50,000
- Register for VAT – although only if their takings are over the VAT threshold (or will be soon)
- From April 2019 you might need to keep records digitally as part of HMRC’s Making Tax Digital (MTD) roll out.
You’ll also need to know about a system called Payment on Account. If more than 80% of your income gets taxed through PAYE, then this won’t apply to you. Otherwise, if your Self Assessment tax bill is more than £1,000, you’ll need to make a payment on account.
This means that, in addition to the 2020/21 bill that you need to settle by midnight on 31st January 2021, you also need to pay half of your total expected tax for the 2021/22 year tax by the same deadline. The other half of the 2020/21 tax bill is then due on 31st July 2021.
As is the case for limited companies, failure to meet these obligations could mean hefty penalties.
Sole Trader business advantages
- Cheap and simple to operate
When setting up as a sole trader, you won’t need to employ the services of a solicitor or company formation agent (as some people do when they form a limited company) so, unless you hire an accountant from day one, there are no professional fees to pay at the outset. Accountancy costs can also be cheaper as there are far fewer statutory filings and reporting deadlines.
- You don’t have to deal with Companies House, only HMRC
There’s no need to register with Companies House because, although you have a bona fide business, it isn’t a company. Youwon’t have to pay a registration fee to Companies House, which will make you a tidy saving of about £13.
- Easy to set up
There’s a simple three-step process to starting out as a sole trader:
- Let HMRC know you’re self-employed
- Register for Self-Assessment as a sole trader
- Pick a business name.
Subject to obtaining any industry-specific licenses you may need, you’re free to start trading immediately after that.
- Has less admin works
You can avoid all the extra paperwork involved in setting up as a limited company (Annual Accounts, Corporation Tax Return etc.) if you follow the sole trader path.
As a sole trader, you’ll have to keep accurate records of sales and expenses, but operating in this manner is much simpler thanks to the fact that you’re only submitting a Self Assessment (and perhaps a VAT return).
Filing forms at Companies House – for example, to appoint or remove directors, allot new shares and suchlike – are irrelevant to a sole trader, as is the requirement to maintain a list of statutory registers. You’ll avoid the constant menace of IR35 too, as these HMRC rules only apply to those operating as a limited company.
So, you’ll spend less time doing paperwork and hopefully more time earning money.
- Has more privacy
While a limited company’s accounts and certain details about company directors are available for public inspection via a few clicks on the Companies House website, as a sole trader you are protected by HMRC’s taxpayer confidentiality rules.
Because your details are private, your rivals have less information about you, which makes it harder for them to size you up and compete with your business.
Disadvantages of being a Sole Trader
- You are personally liable for the debts of the business
The biggest downside comes in the form of unlimited liability, meaning should your business incur any losses your personal property or belongings could be up for grabs by your creditors.
This can happen because, in the eyes of the law, there is no difference between the person running the business and the business itself. When it comes to chasing money owed by a business, a sole trader has to settle up. The sole trader is liable for any debts that the business incurs.
- It can be less tax efficient
Operating as a sole trader can be tax-inefficient, and going limited could offer the potential for greater profitability once your earnings go over a certain threshold.
- Customers, suppliers, and competitors will see you’re a small business
Greater employability and greater borrowing power can come with incorporating too, as banks and big businesses are generally warier of doing business with sole traders. The sole trader structure is often considered better for the rookie freelancer, whilst going limited will generally suit the more seasoned freelancer or contractor.
Find out more in another blog about ‘How To Pay Yourself As A Sole Trader’
Is being a sole trader right for your business? Please give us a call on +44 07828 580251.
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