What is a sole trader?

Chris Andreou

June 2, 2021

what is sole trader guide

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Introduction

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. 

What is a sole trader?

Self employed individual looking at calculations on becoming self employed vs a limited company

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 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.

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What are the benefits of being a sole trader?

Balloons showing the opportunity 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. 

Fewer compliance requirements

Compared to a limited company director, there are fewer statutory requirements that you need to fulfill as a sole trader. There's no need to register with Companies House or file a confirmation statement annually, and there's generally less paperwork involved.

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.

What are the drawbacks of being a sole trader?

Sole Trader Caution

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

Sole trader writing list of 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 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. 

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What's Inside:

  • What is a Sole Trader?
  • Sole trader advantages
  • Sole trader disadvantages
  • How to register self employed
  • Sole trader responsibilities
  • Self employed tax
  • Important self employed deadlines
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Self Employed Registration Guide

What's Inside:

  • What is a Sole Trader?
  • Sole trader advantages
  • Sole trader disadvantages
  • How to register self employed
  • Sole trader responsibilities
  • Self employed tax
  • Important self employed deadlines

Other responsibilities

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 resource 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. 

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What are Personal service companies?

While there isn't a legal or formal definition of the term, personal service companies (PSC) refer to limited companies that are owned by a contractor, who is also the only shareholder and sole director. In some instances, the company may also be owned by a very small group of individuals.

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5 advantages of a limited company

The advantages of operating as a limited company are well known. It can be a great way to maximise your take-home pay, improve your credibility with customers and limit your personal liability. Like most things in life, it's a case of what's best for your situation. While the positives outweigh the negatives for most people, there are a few things you should know before you make the jump to a limited company.

In this article, we'll outline the disadvantages of operating as a private limited company. Bear in mind that there are many advantages to a limited company and in many cases, these advantages will outweigh the disadvantages, so don't think of this as a report of doom and gloom.

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What is a Sole Trader: Meaning & Definition

7 Characteristics For Defining Sole Traders

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What type of business structure is best for you?

If you're looking to the future with the hopes of beginning a journey running your own startup, chances are you're feeling some mixture of excitement, trepidation, and uncertainty when it comes to the finer details of your plan.

Starting your own business is an immensely fulfilling process and an excellent means to flex your creative muscles, but there's a lot of humdrum of business behind the process of turning a vision into a dream.

One of the most important (and one of the earliest) decisions in this process will centre around your business's formation. You'll have to select which type of business structure best suits your goals for the future.

While the choice may sound easy, you'll be well-served by giving the decision ample consideration. The business structure you select will have measurable implications on the way you make money and do business. It'll impact:

  • How much tax you pay
  • Your degree of personal liability should the business fail
  • How much administrative work is involved in the business (both before it comes to fruition and over the course of its life)
  • Your ability to finance and fund your efforts

If you make the wrong selection when it comes time to choose a business structure, you could be faced with a myriad of complications in the future.

Paying professionals for guidance and advice once things go wrong is costly and, for many, an embarrassing affair-performing research well in advance will ensure you're making the best choice for your company and that you can avoid losing out on money or pride later on.

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How do I register as a Sole Trader?

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5 disadvantages of a limited company

What are the advantages of a private limited company?

In the UK, the majority of self-employed people operate as sole traders. While there are many advantages to being a sole trader, you could take home more money and give your business a professional edge by setting up as a limited company.

In this article, we'll look at the advantages of operating as a private limited company to see how it could benefit you. If you're interested in seeing whether a limited company could be a good option for your business, check out our Business Structure guide. If you're already operating as a sole trader, making the jump to a limited company is more straight forward than you think.

Advantage 1 ‚- You pay less tax and National Insurance Contributions

Who can turn their nose up at the prospect of increased take-home pay? Well, that's the principle benefit of setting up a limited company and one of the main factors that drive people to switch from a sole trader.

As a director of a limited company, the way you pay tax is different from how you pay as a sole trader. As a sole trader, you'll pay 20% or more on everything you earn over the tax threshold. As a limited company, you typically pay yourself a small salary so you incur as little personal tax as possible. The majority of your income will come in the form of dividends that are taxed at a much smaller rate, meaning you're able to maximise your take-home pay.

As well as the tax benefits, paying the majority of your income through dividends means that you're able to pay less National Insurance Contributions (NICs) as these do not apply to dividend payments.

Example - Here's a quick comparison of the difference in take-home pay for a sole trader and a limited company.

  1. Sole Trader
    Revenue: £40,000
    Expenses: £1000
    Tax at 20%: £5,300
    Class 2 NIC: £158.60
    Class 4 NIC: £2,655
    Take-home pay: £30,886.40


  2. Limited Company
    Revenue: £40,000
    Expenses: £1000
    Corporation tax: £5741.04
    Dividend tax at 7.5%: 1,406.92
    Take-home pay: £ 31,852.04

As you can see, you save £965.64 as a limited company. What's not to like?

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Self employed tax obligations guide

When you're self-employed, you have unique financial obligations-especially when it comes to paying your taxes.

When you work for a larger corporation, or even a relatively small business, your company takes on a large percentage of handling your tax responsibilities for you.

As a freelancer or small business owner, you're on your own. You work as an independent contractor for each of the clients you work for-and they don't take taxes out of your check before they send it to you.

How then should you handle the responsibility of paying your taxes?

This guide will help you get started:

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Sole Trader vs Limited Company

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When do I need a Limited Company?

There is no clear cut time as to when you should start working through your own limited company. With other routes available-such as operating as a sole trader, or working through an umbrella company-it is always worth weighing up what is best for you and your circumstances.

With that being said, if you plan to work as an independent contractor for the foreseeable future, opening your own limited company at the early stages can maximise your opportunities for reaping the benefits of having your own company straight away.

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Registering a Limited Company Guide

  • What is a Limited Company
  • 10 step process for setting up a Limited Company
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How to set up a Limited Company

When you set up a limited company, you'll enjoy many advantages you don't get as a sole trader. Not only is it a tax-efficient way to run your business, it's also a great way to limit your personal liability and increase your credibility with customers. Additionally, it could open new avenues of work that wouldn't be open to you if you were operating as a sole trader, especially some contractor roles.

One of the disadvantages of running a limited company is that it involves a lot of paperwork, but with the help of this guide, we'll clear away the jargon and tell you exactly what you need.

If you're unsure about whether a limited company is right for you, check out our handy article comparing the differences between Limited companies and Sole Traders to see which business entity is right for you.

If you've got more important things to do than dealing with extra admin, you can always take advantage of one of our accountancy packages and we'll do all the forms and applications for you.

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Self Employed Registration Guide

  • What is a Sole Trader?
  • Sole trader advantages
  • Sole trader disadvantages
  • How to register self employed
  • Sole trader responsibilities
  • Self employed tax
  • Important self employed deadlines
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How to register self employed with HMRC

From starting your side business to going freelance full-time, becoming self-employed can feel scary and exciting all at once.

Before you jump right in, you need to ensure that you're staying on the right side of the law- and this begins with registering as self-employed with HMRC.

In doing so, you can be sure that you're paying the right amount of income tax and National Insurance Contributions, and thereby avoid paying unnecessary financial penalties.

Ready to get started? We've got all the information you need below:

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What are the advantages of a Limited Company?

The advantages to setting up a limited company are:

  • Owners aren't fully liable
  • Tax savings
  • Using a limited company structure lends credibility to your business
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Key considerations when you register a Limited Company

As a freelancer, contractor, or small business, it is typical to start with the simple structure of operating as a Sole Trader.

While taxes and other administrative work may be relatively easy when you are a Sole Trader, as your volume of business goes up, there are more and more reasons to take on the task of becoming a Limited Company.

For instance:

  • A Limited Company protects your personal assets. If you are found liable in a lawsuit, only your business assets are at risk.
  • A Limited Company is usually more tax efficient than being a Sole Trader.
  • Once you have your name chosen as a Limited Company registered through Companies House, no one else can take your company name.

Luckily, running a Limited Company doesn't have to be exceedingly complex, though following a set plan will help to keep the complexity to a minimum.

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3 Ways to Register Your Company for Free

Registering a company is a one off cost of £12 and done through Companies House. However, there are a few different ways that you can get this fee waved with other business services that you need.

We'll walk you through how to register your company for free and the perks that you'll get with each.

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How do I register a limited company?

There are a couple of ways to go about registering a limited company:

  • Register directly through Companies House
  • Go through a third party: An accountant or company formation service can help you process your application, significantly lessening your admin burden. Beyond the application, a good third-party service can also provide accounting advice, help you fulfil your filing obligations and assist with other admin tasks.

We've included further details in our guide on setting up a limited company.

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What are the disadvantages of a Limited Company?

The drawbacks to setting up a limited company include:

  • There are additional filing and reporting requirements to adhere to.
  • Reduced privacy
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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.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
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When do I need a Limited company as a contractor?

There is no clear cut time as to when you should start working through your own limited company. With other routes available-such as operating as a sole trader, or working through an umbrella company-it is always worth weighing up what is best for you and your circumstances.

With that being said, if you plan to work as an independent contractor for the foreseeable future, opening your own limited company at the early stages can maximise your opportunities for reaping the benefits of having your own company straight away.

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