As part of our Freelancer Basics series, we’ve been brushing up on the legal structures out there available for the self-employed. Today we’re turning our attention to the most popular freelancing setup; the sole trader model.
Firstly, let’s tackle some of the legalese. As the term suggests, when operating as a sole trader you’re running your business as an individual. Bear in mind that sole traders aren’t legally required to work alone though – they can take on staff – this merely means that there’s no legal distinction between the owner and the business.
Now, these legalities manifest themselves in a number of ways, and as a sole trader you’ll be –
Personally responsible for any losses your business makes
Personally responsible for any of your businesses bills
Personally responsible for keeping accurate records of your businesses sales and spending
With regards to that last one, this is integral from financial perspective, sole traders carrying a number of tax fuelled responsibilities…
The tax responsibilities
To keep HMRC happy sole traders need to do the following things –
Send a Self Assessment tax return every year
Pay Income Tax on any profits their business makes
As is the case for Limited Companies, failure to meet these obligations could mean hefty penalties,
So why be a sole trader?
Many freelancers begin as sole traders, due to the relative ease of setting-up and the comparatively small administrative burden involved.
The extra paperwork involved in going limited (Annual accounts, Corporation Tax Return etc.) is avoided as a sole trader. Operating in this manner is much simpler thanks to the fact that you’re only submitting a self-assessment (and perhaps a VAT return).
What are the downsides?
The biggest downside comes in the form of unlimited liability, meaning should your business incur any losses your personal belongings could be up for grabs by your creditors.
This can happen because, in the eyes of the law, there is no difference between the person running the business and the business itself – when it comes to chasing money owed by a business, a sole trader has to settle up. The sole trader is liable for any debts that the business incurs.
Elsewhere, operating as a sole trader can be tax inefficient, and going limited offering the potential for greater profitability once your earnings go over a certain threshold. Greater employability and greater borrowing power can come with incorporating too, as banks and big business are generally more wary of doing business with sole traders.
The sole trader structure, then, is probably better for the rookie freelancer, whilst going limited will generally suit the more seasoned freelancer. An accountant can tell you when right time might be to make the move.