Sole trader definition plus the advantages and disadvantages of being a sole trader all explained
The term ‘sole trader’ relates to the way in which a business pays tax and national insurance.
Between a sole trader and their business, there is technically no legal distinction. Therefore, in the eyes of the government, all of the business’ profits are classed as the business owner’s (sole trader’s) personal income.
Because a sole trader’s national insurance and income tax aren’t automatically deducted from their trade’s income, HMRC must be informed about any income received via a Self Assessment form: the system HM Revenue and Customs (HMRC) uses to collect Income Tax.
The government has recently introduced Making Tax Digital (MTD), requiring businesses with a taxable income over the VAT threshold (£85,000) to maintain digital records and submit digital VAT returns.
Read on for a fuller-fat definition of what it means to be a sole trader, the responsibilities involved, plus the advantages and disadvantages of being a sole trader.
This article will cover:
- Sole trader definition
- Sole trader advantages
- Sole trader disadvantages
Sole trader definition
As the name suggests, a sole trader is the only owner of a business, meaning that they are responsible for the entire operation and are considered self-employed.
Being a sole trader involves shouldering the responsibility for any business losses, all bills and business accounts (meaning that accurate records of sales and spending must be kept diligently).
The Department for Business, Energy & Industrial Strategy 2018 report reveals that the majority of businesses in the UK are sole trade operations (almost 60% to be exact). Plus, 75% of UK businesses don’t employ anyone aside from the owners.
Sole trader responsibilities include:
- Choosing a sole trader business name (this can’t include: ‘limited’, ‘Ltd’, ‘limited liability partnership’, ‘LLP’, ‘public limited company’ or ‘plc’, nor can it be offensive or the same as an existing trademark)
- Deciding what to sell/trade
- Sourcing and replenishing stock/supplies
- Pricing and marketing the product or service
- Driving and making sales
- Keeping thorough and accurate accounting records
- Registering as a sole trader with HMRC (there’s a fine for not doing this, so it needs to be one of your top priorities)*
- Completing an annual self assessment tax return
- Registering for VAT (if your annual turnover is over £85, 000)
* The latest you can register with HMRC is by 5 October after the end of the tax year during which you became self-employed. The tax year runs from 6 April one year to 5 April the next.
Sole trader advantages
With so many established sole traders in the UK, there must be some pretty attractive advantages to the sole trader lifestyle. These include:
As a sole trader you can set your own parameters for working, so you’re no longer restricted by the old nine to five lifestyle.
- You’re your own boss
Sole traders work for themselves, so don’t have to answer to anyone and have complete control over the ins and outs of the business. This comes with a great sense of self achievement.
- It’s relatively easy to set up
All you need to do is register for self assessment to pay sole trader tax, this can be done online very quickly.
If you haven’t registered to become a sole trader before, HMRC will send you a letter with your 10-digit Unique Taxpayer Reference after registration (UTR) and set up your account for the self assessment online service.
If you’ve filed a tax return online before, you’ll need to re-register by filling out a CWF1. Note: you’ll need your 10-digit UTR from previous registrations.
If you’re working in the construction industry as a subcontractor or contractor, you’ll need to register for the Construction Industry Scheme with HMRC.
Sole trader cons
Whilst setting up as a sole trader comes with many undeniable advantages, there are also some drawbacks to consider:
A sole trader carries the responsibility of accepting unlimited liability for their business finance – meaning that if the business goes bust and files for bankruptcy, the business owner themselves is considered bankrupt. Such unlimited liability could mean a sole trader ends up selling high-value possessions like their car, or even their house, to save their business from going bust. This can lead to a lack of security for sole traders.
Sole traders can find it difficult to ‘shut-off’ from their work due to the heavy personal responsibility involved. Taking time off can be tricky and for those sole traders who operate alone, it can get a little lonely at times.
- Financial risk
As a sole trader is the business, instead of the business existing as a separate legal entity (as would be the case if you formed a limited company), any business debts are the trader’s debts, making a sole trader completely financially liable for all of their business operations.
- Sole traders have to be a ‘Jack of all trades’
Being the one-man-band behind a business requires skills in all areas: managing potential staff, marketing, sales, production, accounting… the list goes on. Taking on the responsibility for all aspects of a business requires complete dedication and willingness to be versatile – so be mindful of the challenge and don’t bite off more than you can chew.
To summarise, being a sole trader means being entirely responsible for your business. Sole traders pay a higher level of income tax, rather than company tax, as the business’ profits are classified as personal earnings. This means that filling out an annual annual self assessment tax return is essential.
If you’re thinking of setting up a business that won’t incur many debts, then becoming a sole trader is a good option. However, if the business is likely to fall into debt before it becomes fully profitable, then registering as a limited company would be the preferable option.
As the business grows, it is also possible to establish as a sole trader then become a limited company at a later stage to reduce the personal risk and financial liability involved in running a sole trader operation.
To make the move from sole trader to limited company, you ‘incorporate’ (register) online at Companies House. The sole trader business name can also be used throughout the sole trader to limited company transition (as long as no one else has taken the name), the only difference will be that ‘Ltd’ will be added at the end of the business name.
– How do I register as a sole trader?
Sole traders must register with HM Revenue and Customs. Contact Us
– What information do I need to provide?
You’ll need to supply information such as:
- National Insurance (NI) number
- date of birth
- postal address
- telephone number
- email address
- name of business
- what type of work you do
- start date.
If you don’t have an NI number, you can apply for one from Jobcentre Plus on 0845 600 0643, or textphone 0845 600 0643.
If you have an NI Number but you can’t find it, you’ll need to go online and fill in form CA5403. Alternatively, call 0300 200 3502 or textphone 0300 200 3519.
How soon do I need to register?
Register as soon as you can after starting your business. At the latest, you should register by 5 October in your business’s second tax year. For example, if you start working as a sole trader between April 2018 to April 2019, you should register before 5 October 2019. If you register later than this, you won’t get a penalty as long as you send your Self Assessment tax return and pay your bill on time.
How much does it cost to register as a sole trader?
It costs nothing to register as a sole trader.
– How do I register for Self Assessment?
If you’re a sole trader you’ll need to register for Self Assessment. Ensure you register by 5 October in your second tax year. How you register depends on your circumstances: Contact Us to register.
– How long does registration take?
It takes 10 working days (21 days if you’re abroad) to complete the registration process. HMRC will post you an authorisation code.
– How do I update these details if they change?
If your details change, inform us
– When do I need to submit my first tax return?
You need to report your self-employment income by submitting a tax return after the end of each tax year. The tax year runs from 6 April to 5 April the following year.
The deadlines for submitting your return and paying any money you owe are:
- paper tax returns: 31 October
- online tax returns: 31 January
- pay tax you owe: 31 January following the end of the tax year. There are rules surrounding making payments on account – see guidance from GOV.UK
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