What is a sole trader?
Once you’ve decided to enter the world of self-employment, you’ll need to decide how to structure your business. The two main options are to operate as either a sole trader or a limited company. Thanks to low costs and less administration and paperwork, the sole trader route is often preferred by those just starting out.
A sole trader is defined as a person who is the exclusive owner of a business, entitled to keep all profits after tax has been paid, but liable for all losses. It’s a form of business ownership common in the UK that provides you with maximum ease and flexibility, but it also offers very limited protection.
As the term suggests, when operating as a sole trader, you’re running your business as an individual. Despite the name, there’s nothing to stop a sole trader taking on staff, but unlike limited companies, this merely means that there’s no legal distinction between the owner and the business.
This jargon-free article will set you up with all the basic knowledge you need to hit the ground running as a sole trader.
Limited company or sole trader?
Choosing the right legal structure is often the first hurdle for anyone making the switch to self-employment, and there are a few advantages and disadvntages of limited companies and sole traders to weigh up when making this change.
Many freelancers begin as sole traders due to the relatively easy setup, and the comparatively small administrative burden involved. Both sole traders and limited company directors are required to submit a personal Self Assessment to HMRC, but the latter must also submit extra paperwork (such as Corporation Tax and annual accounts). Once you've determined the right legal structure for your circumstances, you'll be able to utilise our online tax calculators. If you opt for the limited company option, you'll be able to use these resources to calculate any dividend tax you owe, as well as being able to work out capital gains tax you may have amounted in the given period.
Accountancy costs are also usually cheaper compared to those involved with running a limited company due to the reduced amount of statutory filing and reporting involved.
However, perhaps the biggest downside comes in the form of unlimited liability, which means in the eyes of the law, there’s no difference between the person running the business and the business itself. Should your business incur any losses, your personal belongings could be up for grabs to your creditors.
Operating as a sole trader can also be less tax efficient. Setting up as a limited company offers the potential for higher take-home pay once your earnings go over a certain threshold.
In general, the sole trader structure is better suited to those just starting out, while setting up a limited company will generally suit the more seasoned freelancer or those doing business with larger clients. If you think a limited company may be of interest, we have another article, “What are the main advantages of a limited company”, that can help. If you don’t already have an accountant, speak to one of our friendly advisors who can help you decide what’s best for you.
Get a business bank account
It’s not a legal requirement when you’re a sole trader, but it’s highly recommended that you set up a separate business bank account.
As a sole trader, all of your business profit is taxable to you personally, and legally there is no difference between you and your business. But unless you want to pay more tax than necessary, you’ll usually want to claim sole trader business expenses. You need to be able to prove what your business expenses are, and be sure that they’re all allowable. Having them mixed up with your personal expenses can cause all sorts of headaches.
Registering as a sole trader
One of the great things about being a sole trader is that setting yourself up is incredibly easy. All you need to do is notify HMRC that you’ll be paying tax through Self Assessment, and you’ll need to file a tax return each year. We recommend you register as soon as you start to work for yourself. HMRC says you must do it as soon as you earn more than £1,000 from self-employment in a tax year (the tax year runs from 6th April to 5th April every year). Best of all, you can do it all online via HMRC’s website.
Choose a name for your business
This is a big step and one that can be fun, you don’t have to be boring and simply use your name – your business name can be anything, within reason.
There are a few rules you need to be aware of and your chosen business name may already be taken, so our article ‘How to come up with a great business or company name’ is a good place to start.
Invoicing and getting paid
The really important part of being self-employed - getting paid! You’ll need to invoice your clients for the work you’ve done or the goods you’ve provided. Invoicing is pretty simple - it’s basically telling your client how much to pay you, how to pay you, when to pay by, and what work you have done.
There are certain legal requirements on invoices, such as a unique identifier or invoice number and your business name and address. We explain everything you need to know in our article “How to invoice your clients”.
One of the biggest challenges you’ll face working for yourself is balancing your income and outgoings - what’s known in the business world as cash flow. Clients, especially more high-profile ones, are renowned for not paying up on time.
The first step, as we mentioned above, is to make sure you send out a proper invoice. The key to getting paid on time is to be proactive in handling your outstanding invoices. By staying on top of your invoices, you’ll ensure your payments arrive on time, and you’ll also more easily spot early warning signs that indicate a problem.
Our free accounting software, Crunch Free, allows you to easily personalise your invoices, set up your clients, and send an invoice, wherever you are. You can automate reminders and easily see what you’re owed and what you’ve paid out. No more searching for your receipts and records when you need to file your accounts or your Self Assessment.
When you're self-employed, you’ll usually be paid directly by your clients. Unlike employed people who are taxed at source through the Pay As You Earn (PAYE) system, you’ll usually be paid without any tax being deducted. So, as mentioned above, you’ll need to file a personal tax return or Self Assessment each tax year.
When you begin paying tax as a sole trader, you will need to keep records of your personal and business income and outgoings as you go (more on expenses later) and HMRC will calculate the tax and National Insurance you need to pay based on your profits. You’ll usually make two payments each year on the 31st January and 31st July.
Sole traders pay two types of National Insurance Contribution (NIC) - one rate that’s charged weekly at a set amount, another based on a percentage of your profits over a certain threshold. Our knowledge article explains everything you need to know about self-employed National Insurance. You’ll also have to pay Income Tax via your Self Assessment at the usual rates charged for personal income. See our tax rates and thresholds page for all the latest figures.
It can be handy to use a take-home pay calculator to work out an estimate of your income after tax. Crunch provides a free and easy-to-use take-home pay calculator so you know what to expect with your next pay.
You can voluntarily register for VAT at any stage, however, registration is mandatory if your turnover for the past 12 months has exceeded the current VAT threshold. Also, if you believe your turnover will exceed the threshold within any 12 month period, then you need to register.
If you foresee your turnover increasing, you must allow enough time to register before reaching the threshold. If you fail to notify HMRC in the proper time, you may be liable for a financial penalty.
Whether being VAT registered is right for you depends on your circumstances - an accountant will be able to advise you.
As a sole trader, you claim your expenses when you file your annual Self Assessment.
Sole traders can claim back any expenses they have incurred that relate directly to their business in much the same way as limited companies. This even includes a percentage of the space used for working if you work from home.
Here are a few examples of what you can claim:
• Office costs - eg. stationery or phone bills
• Travel costs - eg. fuel, parking, train or bus fares
• Clothing expenses - eg. uniforms
• Staff costs - eg. salaries or subcontractor costs
• Things you buy to sell on - eg. stock or raw materials
• Financial costs - eg. insurance or bank charges
• Costs of your business premises - eg. heating, lighting, business rates
• Advertising or marketing - eg. website costs
Bear in mind that you’re legally bound to keep business records (including receipts) for six years after the tax year they relate to.
We’ve got a handy article with more information about business expenses when you’re self-employed.
If you’re in any doubt as to what you can claim, contact your accountant for advice.
Our Crunch Free software is the perfect way to record all your expenses when you’re a sole trader. We even have a handy app “Snap” that lets you take a photo of your receipts and automatically uploads the details to your software.
Business insurance comes in many shapes and sizes - you can’t just buy business insurance and be done with it. You’ll need to pick and choose what policies are a good fit for you and your business.
Here are the options you’ll need to consider if you work for yourself.
Professional indemnity insurance
This covers you if a client suffers financial loss as a result of your professional advice or service. For example, it could protect you against a compensation claim from a client for negligence or mistakes, covering the potentially expensive legal costs.
It’s not required by law, but is recommended for more risky professions, as it will basically cover you for any mistakes you might make.
Public liability insurance
Although not required by law, this kind of insurance is essential if members of the public will be interacting with your business in some way - from customers receiving deliveries, to clients visiting your office or work premises.
If you work from home and meet clients at your home office, then you should also consider getting this insurance. A policy will cover you if someone is injured in some way by your business, or if you damage third party property when carrying out work.
You can check out our business insurance partner Qdos for your cover and get a 15% discount on your insurance if you’re subscribed to a Crunch plan.
Organising your accounts
Keeping track of income and expenses is a necessary part of working for yourself. As your business grows, you’ll be able to get some help - but there are a few rules you need to follow when you’re just starting out.
1. Be transparent
Anyone can be investigated by HMRC. Depending on what you’ve done, you could face anything from penalties and fines to jail time. Transparency isn’t just best practice for your taxes, it’s best for your business too. It forces you to keep track of all the money that’s coming in and going out. You can then use this information in helpful ways, like planning business strategies or reducing the amount of tax you need to pay.
2. Keep records updated
Set an alarm on your phone for a certain time each week to remind you to do your books. Remember, as soon as you let your accounts get out of hand, a backlog will begin to form that could deteriorate into a massive and potentially expensive headache.
3. Learn more about finance for the self-employed
Bookkeeping isn’t just about tracking your cash flow. There are various ways to analyse your income and expenses to find ways to cut back on costs and make more money. If you’re not sure what you’re doing, there’s a lot of online support. You can forecast your financial situation using a software provided by our partners Brixx. Discover Brixx to begin planning your financial future and visibly see areas you can save in your business.
Is being a sole trader right for me?
Whether going down the sole trader route is right for you depends entirely on your individual circumstances. At Crunch, we’re experts in looking after both sole traders and limited companies. If you want to find out what’s right for you, arrange your free consultation with one of our advisors today.
Explore more of our online resources for sole traders, and crunch some numbers with our easy-to-use online tax calculators.