What is a sole trader?

If you're planning to start out on your own, one of the most important decisions you'll need to make is figuring out how you should structure your business.

As a freelancer, contractor or small business owner, there are three main types of legal structures you should consider:

• Sole proprietorship
• Limited company
• Working through an umbrella company

It's a decision that requires careful consideration, and it's important that you seek advice from qualified professionals when you weigh out the pros and cons of each business structure. To begin with, you need to have a good grasp of the basics-and here's where our guide comes into the picture.

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, and is a popular option for business owners providing services to individuals or other businesses. This includes freelance writers, consultants, graphic designers, plumbers, financial planners, landscapers and fitness instructors.

As a sole trader, you're responsible for all aspects of your sole trader business, and are personally liable for its finances - including losses, bills and maintaining accurate records of your sales and business 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.

1. 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 (you don't need to register at Companies House). 

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 'PLC.'
• 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.
  

2. You have a privacy advantage over other types of businesses

Sole traders can operate with more privacy, as your sole trade business details are made known only to HMRC and do not need to be registered at Companies House.

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. 

3. 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. As a sole trader, you may also claim tax free childcare.

4. Fewer compliance requirements

Compared to a limited company director, there are fewer statutory requirements that you need to fulfil as a sole trader. For example, there's no need to register with Companies House or file a confirmation statement annually, and there's generally less paperwork involved. Your self assessment tax return filing (and paying tax) are also generally more straightforward processes.

5. Ease of termination or transition

The process for terminating a sole trader business is fairly simple: you'll need to notify HMRC that you've stopped being self-employed, finalise your income tax, pay Capital Gains Tax (if applicable) and offset the costs of closing down against your tax bill.

It's easier and cheaper compared to other business structures. If you were to close down your limited company, you'll need to notify HMRC and complete a final Corporation Tax return. In addition, you need to apply to strike off your company, start a Members' Voluntary Liquidation or arrange the liquidation of your company, depending on whether your company is solvent or insolvent.

It's also easier to transition from a sole trader to a limited company, rather than the reverse.

6. You have unlimited liability

It's often said that as a sole trader, you are your own 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. 

7. 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.

8. 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. 

9. Your key sole trader responsibilities:

• Keep records of your sales and business 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 program 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. 

10. 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 self assessment 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 from any self employed person, and you can be fined for failing to keep records. 

11. 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 resource on how to select a business insurance plan that's right for your business.

12. 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. 

We've put together a complete guide on how to register as a Sole Trader (or Self Employed).

We started GoForma to make it easy for Self Employed individuals to easily start and manage their business. With 1-on-1 accounting support, unlimited business advice, accounting software and a Virtual Office we can help get your new business set up in no time. We will also help you maintain accounting records and pay tax.

Once you're ready to set up a Limited Company then we can help walk you through the process and help you decide when you want to make the change from a Sole Trader to a Limited Company.

If you want to speak to one of our accountants then you can book in a free accounting consultation here.