The number of people working for themselves continues to rise and becoming a sole trader is the easiest way to do it. There were around 450,000 sole traders in the UK in 2018, according to the Office for National Statistics (ONS). This is fewer than in 2008 when there were 548,000, which largely seems to be due to the increased popularity of other ways of working for yourself such as starting a limited company.
But sole trader remains an important structure for many people wanting to work for themselves, especially those keen to set up as quickly as possible with the minimum of hassle.
Read this article to find out what a sole trader is and how to register as one. You’ll also discover whether you should opt to register as a sole trader or a limited company if you want to work for yourself, find advice on tax for sole traders and there are tips on financial planning too.
What is a sole trader?
When you start working for yourself, you’re automatically classed as a sole trader, even if you haven’t yet told HMRC.
The main definition of a sole trader is a self-employed person who is the sole owner of their business.
Derek Kelly, CEO of SJD Accountancy, says: “In the UK, self-employed means you are not an employee of a company and you make your own tax and National Insurance Contributions (NICs), rather than having an employer pay them for you.
“A sole trader simply describes the way that a self-employed person can structure their business. You register with HMRC and complete your own self-assessment tax return each year. Once your tax return has been processed, HMRC informs you how much you owe from the previous tax year and the payment deadline.”
Sole trader advantages and disadvantages
Sole trader is one of the simplest business structures to set up. There are low start-up costs and no registration fee payable to Companies House as there is with a limited company.
You can change the business structure easily, for example, if you want to expand and become a limited company later.
As a sole trader, you have no partners to consult with and no need to make joint decisions. This means you keep full control of your business, make all the decisions and keep all the income after tax and expenses.
Limited companies must publish information about their finances, directors and shareholders every year. Sole traders don’t need to do this – their information is kept private. However, this can be a disadvantage if you have potential clients who require this level of transparency.
One of the main disadvantages of being a sole trader is that you have no separate legal status and therefore unlimited liability for anything that goes wrong. For example, if your business gets into debt, your personal capital, including your home, is at risk.
Nick Johnson, managing partner at solicitors Glaisyers, says the more debts and financial obligations a business holds, the more dangerous this personal liability becomes.
“For example, if you own and run a café as a sole trader, and the business goes bust, the lease for the property would be in your name, potentially for many years and you’d be personally liable for paying it,” he says. “If it was a limited company, the lease would go into the company’s name, the company would go into liquidation and the business owner wouldn’t be personally liable. So getting this wrong can ruin people’s lives.”
Another disadvantage is that sole traders can find it harder to secure funding compared with larger companies, and they may find it more difficult to expand the business.
Sole traders can also struggle to compete against larger companies with economies of scale. For example, bigger businesses can buy in bulk, have more capacity to deal with ebbs and flows in demand, are less reliant on one person, and can plan succession.
By contrast, being small means sole traders can be nimble and more responsive – and your clients always get to deal with the boss.
The pros and cons of working for yourself
Many of the benefits of being a sole trader come from working for yourself. Mike Cherry, national chairman of the National Federation of Self Employed & Small Businesses (FSB), admits the biggest attraction is autonomy.
He says: “Self-employed people often state that they have a more positive experience of work compared to being an employee, due to the greater flexibility and independence.
“Self-employment has also opened employment to those who otherwise might not work. It has resulted in [more elderly people being in work] and is helping to unlock some of the potential of female entrepreneurship.”
Mike says one of the biggest challenges for the self-employed is the uncertainty of a regular income stream. Unlike employees, the self-employed have no definite expectation of future income. One month could yield a substantial income and the following one may result in little or none.
Research with FSB members shows that 17% say “not getting paid if I fall ill or take time off for personal reasons” was the number one challenge, with 44% listing this in their top three challenges.
Mike also warns that working for yourself can involve longer hours, with twice the number of self-employed people working over 50 hours a week compared to employees. He also points out that the self-employed face significant challenges in other areas of welfare too. In its current form, Universal Credit does not support the self-employed with their fluctuating incomes adequately.
On the plus side, National Insurance Contributions for self-employed people on average earnings are marginally lower than for employees.
How to register as a sole trader
You need to set up as a sole trader if:
- you earned more than £1,000 from self-employment in the tax year ending in April 2018 – this is your ‘trading allowance’
- you need to prove you are self-employed, for example to claim tax-free childcare
- you want to make voluntary Class 2 National Insurance payments to help you qualify for benefits.
To set yourself up, register for self assessment as a self-employed person. Do this as soon as possible – but no later than 5 October after the end of the tax year.
If you’ve filed a tax return before, register online using form CWF1 – you will need your 10-digit Unique Taxpayer Reference (UTR) from before.
If you haven’t sent a return before, you still register online but the system will lead you to create your Government Gateway account and enrol you for the online service at the same time. You will receive a letter with your UTR and your activation code within two weeks, so you can activate your online service when you first log in.
Then to register, simply fill in your personal details and details for the business where prompted. Once you have checked the details on the next page, you can submit them online.
Sole trader or limited company?
If you want to work for yourself, you can use other business structures apart from being a sole trader. For example, you can become a partner in a business partnership or set up your own limited company, in which case you become employed as a director of that company.
45% of FSB members classify themselves as sole traders, with the remainder mostly partnerships and limited companies. Partnerships can be more specialist, so for many small businesses, the choice is between becoming a sole trader and setting up as a limited company.
One benefit of limited companies – also known as incorporated businesses – is their owners often take much of their earnings as dividends. The dividends regime is slightly more favourable, so it means they pay less tax than sole traders.
However, a sole trader’s tax affairs are much simpler compared to a limited company.
The only choices that a sole trader must make in terms of tax relate to whether they register for VAT.
Nick Johnson from Glaisyers says: “Sole traders have fewer administrative obligations and fewer tax issues to consider. In contrast, limited companies must file annual returns to Companies House, pay tax on the company’s profits, PAYE and NICs for any staff, and there are tax implications for using consultants.”
However, the choice isn’t just about tax, there are many other issues to consider, he reveals.
“A sole trader might want to become limited as their business gets larger, exposed to more debt and employs more people,” says Nick. “Also, a limited company can have a more formal structure, allowing for the business to be run with, for example, a managing director, financial director and marketing director.”
Sole trader tax
As a sole trader, you’ll need to keep records of your business sales and expenses. You are taxed via self assessment and must send a self assessment tax return to HMRC every year. Sole traders pay income tax on profits, after expenses.
For the tax year ending in April 2019, the personal allowance is £11,850. The basic rate of 20% is for income between £11,851 and £46,350. Thereafter, you pay 40% up to £150,000, and 45% above that.
If your turnover is more than £85,000, you must register for VAT and charge VAT on your goods and services. You can register if your turnover is less than £85,000 if it suits your business, for example, or if you sell to other VAT-registered businesses and want to reclaim the VAT.
If you do register for VAT, you must also choose whether to use the VAT flat rate scheme or cash accounting scheme, both of which have their pros and cons. You may want to take advice from an accountant on these choices.
Sole traders and National Insurance
As a sole trader, you have to pay Class 2 National Insurance Contributions if your profits are £6,205 or more a year, and Class 4 contributions if your profits are £8,424 or more a year.
Class 2 NICs are £2.95 a week. Meanwhile, Class 4 contributions are 9% on profits between £8,424 and £46,350 and 2% on profits over £46,350.
If you are moving to the UK to set up a business, you will need to apply for a National Insurance number.
Self-employment and sole trader legal status
There’s no legal definition of a sole trader but as they are self-employed, sole traders should be aware of the laws around self-employment.
One consideration is that anyone working for themselves should be careful not to contravene a rule called IR35, which aims to stop businesses from engaging “disguised employees” on a self-employed basis to reduce their tax bill.
There are several tests to ensure you are genuinely self-employed and one of the key ones is to show you are not controlled by one client as to how, when and where you work. For example, working for at least two clients per month and having some choice over when and where you work for each is a good way to prove self-employment.
If an individual’s employment status is not clear, it could ultimately be determined by an employment tribunal or by HMRC if necessary.
Growing your business
Financial advisory firm Evolution Financial Services is a typical example of how a growing company might move from sole trader to limited company status. Director Andy Rowe says his business partner Bhavik Patel initially set up the business as a sole trader as it was easier to register.
However, the business later became a limited company when Andy joined so they could divide share capital evenly and create more structure to support growth.
Plus, Andy says it enabled the directors to pay themselves a salary and dividends, which provided significant tax advantages at the time. This tax benefit has diminished as the tax rules around dividends have changed, but it is still marginally better compared to being a sole trader.
He says: “Also, as a limited company you have more security and protection, so the extra hassle of registering the company and having to submit company accounts is still worthwhile for us.”
Financial planning for sole traders
Andy has many clients who are sole traders. A typical financial planning process starts with ensuring they have the relevant insurance in place, he says. Depending on their circumstances, this might include income protection, critical illness and life insurance.
Then he would look at the sole trader’s debt situation, which can often be a critical issue. “Sole traders need at least two years’ accounts [showing they have made income] to get a mortgage,” says Andy.
“That includes refinancing an existing mortgage. So sole traders often need to think carefully about that if you are moving from an employed background to self-employed and have a mortgage or plan to get one.”
This can be particularly tricky if the earnings of the business in the first few years aren’t enough to qualify for the mortgage they want.
Next, Andy discusses the pros and cons of setting up and saving into a private pension with his sole trader clients.
“A pension is mostly positive as the tax relief it offers is too beneficial not to take,” he says. “But one potential negative factor is access – if you suddenly need the money, you can’t get it out of a pension until age 55 at the earliest.
“We also check if clients have a will and that they are using all their other relevant tax allowances.”
New sole traders should also search carefully for the best business bank account for their needs and budget. Andy says: “There are challenger banks coming into this space who help make online payments quicker and easier, which is key for a sole trader.”
Often, sole traders can end up with additional money sitting idle in their bank account – if so, an important consideration is what to do with the extra funds.
“If they don’t need this capital for business expansion or immediate cash flow, we look to move it into pensions to get the tax relief,” says Andy. “Or if they want to keep access, it could go into an investment vehicle that should make better returns over the long term compared to bank account interest.”
Copywriter Liz Bell on being a sole trader
Liz Bell, a freelance copywriter and editor at Liz Bell Media, became a sole trader when she went freelance five years ago. She made the move after her first son was born as she wanted more flexibility to spend time with her family than a nine-to-five employed role would allow.
She says registering as a sole trader was easy and simply involved a phone call to HMRC.
“I spent a long time researching the options for self-employment before I started and it has continued to be a learning curve since then,” says Liz. “When I started out, the idea of a limited company was overwhelming.
“It was more expensive and involved much more administration. It also made sense for me to operate as a sole trader as I have no employees.”
Liz says it is only likely to become more tax efficient for her to be a limited company once she starts earning more income.
“As I still have two small children, I don’t work full time, which is reflected in my earnings,” she says. “I have gradually built my business and refined my service as I’ve learned where my strengths lie and what I most enjoy doing.
“I did look into becoming a limited company again when I became more established with a more reliable income. But it is currently still more beneficial in terms of tax for me to be a sole trader.”
Liz recognises the risk of personal liability as a sole trader. But as a writer working remotely, the risk of getting into debt is low, she says. She has public liability and professional indemnity insurance.
“More people are considering self-employment as the job market becomes increasingly competitive, but also people are less willing to settle for job security over doing something they enjoy,” she says. “But, while it’s easy to set up as a sole trader, it can be tough as there is still a vast amount of work involved.
“Attracting and keeping clients, making sure you get paid on time. Networking with other professionals, and continuing professional development all take time and effort. And, of course, you need to be good at what you do.”
Liz admits it can be lonely working for yourself, so getting involved in industry membership bodies, networking with other professionals online and face-to-face, and working at least occasionally from a shared office are all important for her.
“These all involve costs, so you need to factor those in – but think of them as essential business expenses rather than optional extras,” she adds.
Nonetheless, Liz says becoming a sole trader is one of the best things she has ever done.
“I am a freelance evangelist,” she says. “I’m constantly trying to convince friends to take the plunge. I love the freedom and flexibility in setting my own hours and choosing the type of work I do, and for whom. Most of my clients are non-profit and public sector, so I get to do work I enjoy for clients whose causes I believe in – and in a way that suits me and my family. What’s not to love?”
Final thoughts on being a sole trader
It’s a big leap from employment to becoming a sole trader, but one that many find attractive for the control it brings them over their business and their work-life balance. Being a sole trader also brings risks, responsibilities and often much hard work that you must be ready for.
You must consider all aspects of the move carefully – and think about whether you should move straight to a limited company or partnership instead to limit the risk to your personal finances.
But if you have ever dreamed of starting your own business, or just want to work with more control and flexibility, becoming a sole trader is an important option to consider and still the best route for many budding entrepreneurs.
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