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Sole Proprietorship vs Self-Employed

Sole proprietorship vs self-employed

When you think of someone who runs their own business and works for themselves, you may think of them as self-employed or as a sole-trader, or both. But do you know the difference between these two terms? Sole proprietorship and self-employment are often seen as one and the same thing, but there are integral differences between the two, and you can be one without being the other.

It’s important that you understand the terminology, as well as the legal structures available to you if you’re self-employed or looking at working for yourself in the near future.

Is self-employed and sole proprietorship the same thing?

These terms are often used interchangeably, but being self-employed and being a sole trader is not quite the same.

Self-employed means that you work for yourself and do not have a full-time or part-time contract with an employer. Sole proprietorship refers to your business structure and means that you are the sole owner of your business.

There is definitely a crossover of these terms as all sole traders are self-employed, but not all self-employed people are sole traders as there are other business structures available to self-employed people, such as partnerships and limited companies.

So while these terms are not the same, they are often used interchangeably when referring to someone who runs their own business.

Do you pay more taxes as a sole proprietor?

Employed people, sole traders, and limited companies are all taxed differently. When it comes to employed people, they don’t really need to worry about tax as their employer takes the tax off of their salary and pays it for them.

Limited companies are taxed as completely separate entities from their owners and are subject to corporation tax, while sole traders need to pay their tax in the form of a yearly Self Assessment. As a sole trader, you’ll also need to pay NIC based on how much profit your business makes.

It’s very important for sole traders to keep detailed financial records and keep track of any money used to pay themselves or money that has been moved over into their personal finances. Any profits made as a sole trader will be taxed. There are varying levels of tax, including:

  • If you make between £12,500 and £50,000 in your first year of trading, you’ll need to pay 20% in tax
  • If you make above £50,000, you’ll be bumped up into the 40% tax bracket

 

The tax involved in limited companies is not as simple. Your salary is not taxed and is considered a business expense. Once you’ve deducted your salary from your profits, you’ll pay 19% corporation tax of what is left, considering if your profits were £50,000 before salary deduction. Depending on how much of a salary you take, you may need to pay an Employer’s Contribution.

On the lower end of the profit spectrum, it is the limited company that would pay less in tax so long as they are smart about their personal salary etc. But as profits increase to around the £300,000 mark, it appears that the sole trader will get to hold onto more money at the end of the day.

It should also be noted that sole traders have a substantially more simple tax structure, while limited companies are a bit more complex. Either way, as a self-employed person, you will be completely responsible for paying your own tax. In many instances, you’ll actually be able to save money by getting a tax professional to assist you and ensure that everything is done correctly and with your best interests in mind.

It is near impossible to say whether sole proprietors pay more tax than limited companies. It’s best to fully investigate both tax structures and choose the one that is best suited to your business venture.

Do I have to be a sole proprietor when I’m self-employed

While most self-employed people register as sole traders (or sole proprietors), this is not the only option available to you. Structuring your business as a sole trader merges your personal finances with your business finances and gives you full responsibility for your business. Your other options are:

  • Business partnership –  A business partnership is structured in a very similar way to a sole proprietorship, except it is divided between two or more partners or co-owners.
  • Limited company – This type of business is structured as its own legal entity, thus separating your business and personal finances.

It’s important to research these different structures and choose the one that is most suitable to you and your business ideals and goals.

Registering as self-employed and a sole trader

If you decide to work for yourself, even if you’re still holding down a job, you’ll need to inform the HMRC within three months of you doing so. It is a very easy and straightforward process when it comes to registering on their online portal, and you can easily register within an hour. Once you’ve registered, you’ll be responsible for completing your own tax in the form of a Self Assessment each year. You’ll also be responsible for paying your NIC.

If you’d prefer to structure your business as a limited company, you’ll also need to register your company with the Companies House.

Why do most self-employed people register as sole traders?

Registering as a sole trader is the simplest process that involves the least amount of admin and paperwork. Most people who are transitioning into a self-employed lifestyle may not be 100% sure where their business is going, and it can be easier to first register as a sole trader and then change to something else should it be required than vice versa. Being a sole trader gives you quite a bit of flexibility and is a great starting point when starting your self-employed journey.

While most self-employed people are listed as sole traders, this is not the best route for everyone. Look into the advantages of registering as a partnership and a limited company, and go from there. There is no ‘one size fits all’ solution when it comes to being self-employed. 

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