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What Is A ‘Sole Trader’?

what is a sole trader

A sole trader is the simplest business structure in the UK, owned and run by one individual. Key points about being a sole trader include:

  • Sole traders retain complete control and keep all profits, as there are no partners or shareholders involved. However, they also carry unlimited liability for debts.
  • Minimal paperwork is needed to start, as no formal registration is required. Sole traders just need to register as self-employed with HMRC for tax purposes.
  • They have full flexibility and autonomy to operate how they like. However, they also carry full responsibility for filing taxes, accounting, and staying legally compliant.
  • Sole traders report business profits via annual self-assessment. Their profits get taxed at personal income tax rates, which are usually lower than the corporate tax rate up to around £50k.
  • A sole trader is well suited to freelancers, tradespeople, consultants or casual self-employed occupations. It allows testing business ideas before growing into a larger company.

In summary, a sole trader refers to an individual running their own unincorporated small business personally and taking full ownership of assets plus legal and tax liabilities. It provides a simple, low-risk business structure for anyone eligible looking to work independently.

Sole Traders Explained

A sole trader business is owned and controlled by one person, unlike other business structures that can be made up of multiple partners or shareholders. Many small businesses and startups begin their journey as sole traders since it involves less paperwork and compliance obligations.

To be specific, a sole trader is a self-employed individual carrying out business activities in their own personal capacity, rather than through a separate legal entity. Sole traders personally own all assets and liabilities related to the business. They also take home all post-tax profits earned through trading activities.

Some common examples of sole trader businesses include electricians, plumbers, cleaners, gardeners, decorators, taxi drivers, hair stylists, beauticians, photographers, designers, consultants, trainers and coaches. Essentially any small trade or freelance service business can be set up by an individual as a sole trader.

Pros And Cons Of Operating As A Sole Trader

Pros

  • Quick and easy to register – You can instantly start working as a sole trader with minimal registration paperwork. An accountant can help with tax registrations.
  • Lower ongoing compliance – Much simpler annual accounts and tax returns compared to limited companies.
  • Full control – As the sole owner, you have complete control over all business decisions.
  • Tax efficiencies – Profits are taxed at your personal rate, which is typically lower than corporate taxes if profits are under £50k.
  • Privacy – You are not required to publicly disclose your accounts and finances each year.

Cons

  • Unlimited liability – As a sole trader, you are personally responsible for all business debts which can put your house and assets at risk if things go wrong.
  • Raising finance – It is difficult to raise substantial finance or investment without converting to a company structure first.
  • Credibility – Some businesses find it harder to win larger contracts without being a registered company.
  • Administration hassles – Managing everything yourself can become burdensome over time compared to having a company team handle it separately.

As you can see, there are good reasons to set up both as a sole trader or as a company. We’ll explore the key differences between these structures later on.

What Legal Responsibilities Come With Being A Sole Trader?

While sole traders benefit from simplicity compared to setting up a company, they do still carry a number of legal responsibilities related to taxes, accounting, insurance, and regulations. Some key obligations include:

Income Tax and National Insurance Contributions

You must complete annual self-assessment tax returns reporting your business profits. Tax and NICs are then paid on your profits based on your personal tax rates.

VAT Registration

If your annual turnover exceeds £85,000 (for the tax year) then you must register for VAT. This means charging VAT on sales and submitting quarterly VAT returns.

Bookkeeping and Accounts

You need to keep accurate business records of sales, expenses, assets vs liabilities, as well as submit an annual Self Assessment return.

Business Insurance

Sole traders require specialist insurance covering potential risks like property damage, theft and loss of earnings due to sickness or accidents.

Licences and Regulations

Relevant professional bodies, industry qualifications/accreditations and specific regulations may require registration or licensing depending on your business activities. For instance, waste carriers require a certificate to transport waste materials.

While this may appear daunting, an accountant can guide you through the key registrations and filings needed to stay legally compliant. We’ll cover how accountants can help later on.

How Does Setting Up As A Sole Trader Work?

Becoming a sole trader is a relatively quick and simple process, especially compared to setting up a limited company. Follow these key steps:

Choose Your Business Name

You can trade under your own personal name or choose a unique business name. Just ensure it is not already trademarked and does not imply a partnership or company.

Register With HMRC

You need to register for self-assessment and Class 2 National Insurance contributions by setting up as self-employed on gov.uk. This then covers you for income tax and NI contributions.

Sort Out Business Insurance

Specialised sole trader insurance covers loss of income, property damage, theft, and public liability risks. Shop around brokers to get adequate cover at a competitive price.

Open A Business Bank Account

While you can use a personal account, a specialist business account keeps your finances separate plus offers features like accounting integrations, invoicing and dedicated support.

Get Your Accounts Set Up Properly

Work with an accountant to establish key financial processes like bookkeeping software, invoicing, credit control, payroll (if hiring staff) and VAT registration. This saves time and errors in handling your own finances.

What Is The Difference Between A Sole Trader And Self Employed?

These two terms tend to be used interchangeably, however, there is a subtle legal difference according to Gov. uk:

  • Sole Trader – Describes someone running their own business as an individual while taking on all the business’ responsibilities and liabilities personally.
  • Self Employed – This is a broader tax status that includes all individuals operating a business on their own account. So beyond just sole traders, partners within partnerships and company director-shareholders also count as self-employed.

In summary, self-employed is an umbrella tax term for anyone in business by themselves. Sole trader refers to a specific type of unincorporated business entity owned and run by an individual (rather than partners or company shareholders).

In practice most sole traders will also be self-employed – but some self-employed people like partners and directors are not classed as sole traders specifically.

Sole Trader Vs Limited Company – Key Differences

Sole traders need to decide whether incorporating as a limited company could be beneficial at some point in their journey. Here we’ll summarise the key differences between sole traders and limited companies:

Setup Process

Sole traders can instantly start working – limited companies require more administration like appointing directors and shareholders plus notifying Companies House.

Legal Entity Status

Sole traders operate as individuals so have unlimited personal liability. Limited companies have separate legal entity status protecting directors’ personal assets.

Ownership and Control

Sole traders fully own and control themselves. Limited companies can split ownership and control across shareholders and directors.

Responsibilities and Administration

Sole traders take on all tax/compliance responsibilities themselves. Company directors can delegate some legal/admin duties to accountants.

Access to Finance and Investment

Companies find it easier to access funding from investors, banks and other sources to accelerate growth.

Tax Rates and Compliance

Sole traders pay personal income tax rates with simpler returns. Company taxes are lower but directors also face extra dividend taxes and more complex reporting.

Ongoing Running Costs

Sole traders have minimal recurring fees. Limited companies also incur extra costs like accountant fees, Companies House filings etc which add up.

Credibility and Brand Building

Using ‘Ltd’ and a unique name allows companies to better establish a professional brand and identity.

There are clearly pros and cons on both sides to factor in, depending on your goals and stage of development. We would advise most startups to begin as sole traders – then explore incorporating further down the line once the business fundamentals are proven if needing accelerated growth.

Do I Need To Be A Sole Trader To Work For Myself?

No – being self-employed encompasses a few options beyond just being a sole trader. Some alternatives include:

Becoming a Freelancer

Freelancers are essentially self-employed independent contractors who work on projects or temporary contracts with various clients. They operate like sole traders but some prefer to identify as a freelancer.

Forming A Business Partnership

This involves legally going into business alongside one or more other partners where you share responsibilities, investment, control, profits and liabilities. Less risk than sole trading.

Setting Up A Limited Company

Incorporating creates a separate legal entity owned by shareholders and run by company directors. Requires more setup work but limits personal liability risks.

So in short – there are a few more ways to structure your business beyond sole trading depending on your needs and preferences.

Who Can Become A Sole Trader?

The beauty of sole trading is that it represents an accessible business model open to almost anyone looking to work for themselves. As long as you meet a few basic eligibility criteria, you can launch a sole trader venture:

Over 16 Years Of Age

There is no upper age cap – however, you typically need to be over 16 to meet contractual eligibility and tax requirements (over 18 in some cases).

Legally Allowed To Work In The UK

To legally trade you need the right to work in the UK – e.g being a British citizen, having the right visa, permanent residency etc.

Not Legally Disqualified

You must not be disqualified from acting as a company director nor have previously been declared bankrupt with outstanding debts.

How Can An Accountant Help With Setting Up And Running A Sole Trader Business?

While sole trading is simpler than managing a company, the responsibilities around tax, compliance, accounting and insurance can still feel complex and time consuming.

As a result, most successful sole traders choose to work alongside an accountant or bookkeeper to remain legally protected plus remove distractions from growing the actual business.

An accountant can assist with various aspects including:

Getting Set Up Properly

Helping you formally register with HMRC as self-employed, sort out the right insurance policy and set up an appropriate business bank account to separate your finances.

Keeping Compliant And Protected

Ensuring you complete accurate VAT returns, self-assessment forms, Tax & NIC contributions on time while maintaining proper financial records should HMRC ever investigate.

Accounting Software & Bookkeeping

Advising the right cloud bookkeeping tools for your needs while training you how to capture income/expenses, invoice clients, manage cash flow and reconcile accounts smoothly.

Analysing Finances & Performance

Providing regular feedback on the health of your business by assessing financial KPIs, profit margins, ROI of investments, where cash is really flowing in/out and identifying opportunities for efficiency gains.

This support covers the unglamorous back-office side that keeps you legally protected and helps improve decision making through numbers based insights. It allows you as the sole trader to focus entirely on sales and delivery without burning out on admin.

Most accountants offer flexible support plans scaled to your needs and budget whether you just need an annual Self Assessment return filed or want fuller bookkeeping/advisory support. Bear in mind that their fees also qualify as a deductible business expense lowering your tax liability.

Concluding Thoughts

So in summary – what is a sole trader? At its core, it simply means running a small unincorporated business independently through your own personal capacity and efforts rather than as a separate company with corporate status. If eligible, this provides an accessible structure for anyone to commercialise their skills and become self-employed without needing partners or investment upfront.

Setting up on your own as a sole trader allows almost anyone to unlock the benefits of entrepreneurship with minimal red tape. You can instantly start trading via your personal capacity without needing any formal company registration. It suits freelancers offering skilled services, mobile tradespeople, consultants or casual gig workers in fields like transport and cleaning.

By starting simple as a sole trader you can test and iterate on potential business ideas without major risk or upfront commitment. As long as you handle basic tax and legal responsibilities using an accountant for support, you’ll stay protected while working in a flexible self-employed capacity. You can always transition into a partnership or company further down the line as the business fundamentals are proven over time.

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