What is a sole trader?
A sole trader is a person who is both self-employed and an owner of their own business. If you are a sole trader you will be in complete control of the business, benefit from all profits generated and be responsible for all liabilities incurred. A sole trader has no protection from any debts or other liabilities and can be made personally bankrupt if the business fails. Sole traders can employ people and will be responsible for all income tax and NI (national insurance) issues involved in employing staff.
The sole trader model is one that is used by many individuals offering services such as plumbing, decorating, hairdressing, consulting or by online entrepreneurs.
How do you register as a sole trader?
If your total business income for the tax year is less than £1,000 and you have no other source of taxable income there is no need to inform HMRC or prepare accounts. This £1,000 limit is known as the "trading allowance" and we have provided a full explanation of this allowance later in the article.
If you are a sole trader with a business income of over £1,000 in a tax year then you will need to do the following:
- Visit the HMRC website and register for online services
- Complete the registration form indicating that you are self-employed and will be paying tax as a sole trader
- HMRC will then send you a 10-digit Unique Taxpayer Reference together with an activation code for your online account
- You will then be able to complete your annual self-assessment tax return using this online account.
If the name of your business is different from your own personal name then there some rules you must follow:
- You cannot copy the name of another existing business
- You must include your own name and the name of the business on all business documents
- If the business name is different from your own it must not be offensive or contain sensitive words
There are also some other things to consider if starting a new business.
- It is advisable to open a business bank account to keep your business finances separate from your personal finances
- If you plan to operate from home and are in rented accommodation then you will need to check that your rental agreement permits it.
What are the advantages of being a sole trader?
Easy to set up
Setting up as a sole trader is simple with no requirement to register the company. All you will need to do is inform HMRC that you are self-employed and operating as a sole trader.
Full control of your business
As a sole trader you will have full control over all business decisions without the need to consult with other directors. This will allow you to be more flexible in how you want your business to develop.
As a sole trader you will only need to maintain a record of your invoices and expenses and complete an annual Self Assessment tax return. Alternatively, you can claim the trading allowance (described later) which means that you won't even have to complete a tax return if your income is less than £1,000. If you employ people you need to ensure that all employee taxes are kept up to date together with employee/employer NI contributions.
As your business grows you can create a limited company to provide legal protection for your personal assets as well as appoint directors to assist in the growth of your business. As your business continues over the years you could have a growing asset that you could sell in the future.
What are the disadvantages of being a sole trader?
A sole trader business has no legal entity separate from the owner. This means that any outstanding debts incurred by a sole trader can be pursued against their personal assets even resulting in them losing their home.
As a sole trader you can claim tax allowances on certain business expenses or claim a £1,000 trading allowance, however, limited companies can enjoy greater tax benefits. When a limited company makes a profit they can pay their directors a dividend which currently carries a lower tax liability. These dividends can be in addition to any salary paid to employed directors and provides an opportunity for efficient tax planning.
As a sole trader you are totally responsible for the services or products you provide. If you fall ill or have an accident this could result in your business being put at risk. As a sole trader it may be more difficult to fully insure against such situations or borrow funds to get you through a difficult period.
How much tax does a sole trader pay?
A sole trader will pay income tax as well as National Insurance contributions on annual earnings.
Income tax is paid on annual earnings in excess of £12,570 (2021/21) and the rate paid depends on the level of earnings as shown in the table below. Your earnings are equivalent to your total income less allowable business expenses (or the trading allowance).
|Annual earnings||Tax rate|
|Up to £12,570||Nil|
|£12,570 to £50,270||20%|
|£50,270 to £150,000||40%|
If your annual earnings are over £100,000 your personal allowance decreases by £1 for every £2 of income over £100,000. If you earn over £125,000, you will not receive a personal allowance.
The trading allowance exempts trading, casual or miscellaneous income of up to £1,000 per tax year from income tax. The trading allowance was introduced so that individuals earning a small amount of income, from hobbies or a small business, do not need to inform HMRC or submit a tax return. You do not need to apply to use the exemption but it is available to individuals only, not partnerships. If you do claim the trading allowance you will not be able to claim for business expenses via a tax return. The trading allowance is offset against your business income meaning that if your total income in a given tax year is less than £1,000 then there is no tax to pay. If your income is more than £1,000 then if you claim the trading allowance it is deducted from the total income figure and you pay income tax on the balance.
If your business profit is over £6,475, you’ll need to pay Class 2 NI contributions. If your profit is over £9,500, you’ll also need to pay Class 4 NI contributions as shown in the table below.
|Class 2||Annual profits of £6,475 or more||£3.05 per week|
|Class 4||Annual profits between £9,501 and £50,000||9%|
|Class 4||Annual profits over £50,000||2%|
What expenses can I claim as a sole trader?
Most expenses incurred in the operation of your business can be offset against your income to reduce your tax bill as long as you aren't claiming the trading allowance exemption. The following list shows the main categories of expenses acceptable.
- Business premises - rent, insurance, utilities
- Transport cost - business use only
- Office equipment - stationery, postage, phone, internet
- Legal and professional costs