Thinking about going self-employed? There are several business structures you can choose from, and becoming a sole trader is one of your options.
If you're looking for a guide that provides an overview of the essentials, here's the article you need. Below, we'll dive into what it means to be a sole trader, discuss the pros and cons, and list out the ongoing responsibilities that sole traders are required to fulfil.
What is a sole trader?
A sole trader, or sole proprietorship refers to a business structure whereby one individual runs and owns the entire business. The sole trader model can be used by a wide variety of businesses. A few examples are freelance writers, graphic designers, restaurants, financial planners, landscapers and fitness instructors.
As a sole trader, you're responsible for all aspects of your business, and are personally liable for the finances of your business - including losses, bills and maintaining accurate records of your sales and expenses.
Do note that the term refers to the structure of the business, and not the number of employees. While a sole trader is self-employed, it doesn't necessarily mean that they work on their own without hiring employees.
What are the benefits of being a sole trader?
It's easy to set up
Setting up a sole trader is fairly simple: you'll need to register as self-employed with HMRC, register for Self Assessment to pay sole trader tax and choose a business name.
There are a few rules you need to keep in mind when naming your business:
- A sole trader name can't include 'limited', 'Ltd', 'limited liability partnership', 'LLP', 'public limited company' or 'p.l.c.'
- Your proposed name shouldn't infringe an existing trade mark. You'll need to check the UK Intellectual Property Office trade marks register.
- Ensure that your proposed name isn't the 'same as' an existing name. Do a check using the company name availability checker tool on Gov.uk.
- It shouldn't be offensive, nor contain sensitive words and expressions. For further information on sensitive words or names you should avoid, check out these resources on Gov.uk.
You have a privacy advantage over other types of businesses
Sole traders can operate with more privacy, as your business details are made known only to HMRC. This is not the case for incorporated businesses, as business details-such as your company accounts and confirmation statement-can be viewed by the public once these are filed at Companies House.
You have full control
As a sole trader, you'll have full control over your business-including how your day-to-day operations are run, how you want to scale your business and what you want to do with your after-tax profits. You won't have to include shareholders in your decision-making process, nor be concerned about regulations that limited companies need to abide by.
What are the drawbacks of being a sole trader?
You have unlimited liability
It's often said that as a sole trader, you are the business. That's because unlike a limited company, a sole trader business isn't a separate legal entity; the law doesn't distinguish between the individual running the business and the business itself. You're personally liable for the debts that your business incurs, and your personal assets can be seized to pay off these debts.
It can be tax inefficient
You may benefit from greater tax savings if you run your business as a limited company, particularly if your profits go above a certain threshold. That's because limited companies pay 19% Corporation Tax on their profits, compared to the 20-45% Income Tax that sole traders pay on their profits.
In addition, a limited company offers greater flexibility for tax planning. Directors can minimise their personal tax and National Insurance Contributions by paying themselves a combination of a salary and dividends, or defer tax by reinvesting surplus income or withdrawing their profits at a later tax year. In comparison, sole traders have less flexibility to work around the tax system.
You need to juggle multiple roles and priorities effectively
Many sole traders run a one-person business, where they need to juggle multiple responsibilities and conflicting priorities effectively-from managing the sales and marketing, to customer support and more. The key to getting this right is to delegate or outsource non-core activities, such as accounting or administrative tasks wherever possible, so you'll have more time on your hands to focus on growing your business.
Sole trader tax responsibilities
As a sole trader, you need to:
- Keep records of your sales and expenses
- Send a Self Assessment tax return every year
- Pay Income Tax on your profits and National Insurance Contributions
You may also need to:
- Register for VAT if you expect your VAT taxable turnover to be more than ¬£85,000 in the next 30-day period, or if your business had a VAT taxable turnover of more than ¬£85,000 over the last 12 months. There are other cases where you might be required to register for VAT, and we'll explain this in detail in a separate article.
- File VAT according to Making Tax Digital (MTD). MTD is the government's programme to transform the tax system and move it fully online. Here's an article by Gov.uk if you need more information on how you can get ready.
- Register with HMRC for the Construction Industry Scheme (CIS). This will only apply if you're working in the construction industry as a subcontractor or contractor.
Maintain proper records:
Make sure to keep track of all sales and income, expenses, as well as payroll records if you have employees. Ensure that you've kept a copy of important documents-such as receipts, bank statements and invoices. After you've filed your tax return for a specific year, all relevant documents pertaining to that year must be kept for five years. That's because HMRC may ask to review these, and you can be fined for failing to keep records.
Have the right insurance in place:
The insurance you need will vary, depending on the type of business you're running or the risks you face. Core covers for sole traders include public liability, professional indemnity and employers' liability (if you have employees). For further information, check out our guide on how to select a business insurance plan that's right for your business.
Abide by health and safety requirements:
Preparing a health and safety policy, obtaining insurance for your business and having the right workplace facilities in place are some examples of health and safety standards you need to abide by. For a quick overview of the basics, check out this resource by HSE.
It can be challenging figuring out which is the best structure to use. If you require personalised advice, consider consulting an accountant. At Forma, we offer a free consultation where our advisers will run you through the essentials and answer any questions you may have.
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