What is sole trader?

A sole trader is a self-employed person who runs and owns their own business by themselves. If you're a sole trader in London, you have no legal identity separated from your business. Due to this, many people describe sole traders as a business themselves.

In another article, we look in detail at sole trader advantages and disadvantages.

How does a sole trader differ to a limited company?

Overall, the main difference between a sole trader and a limited company is that a sole trader is owned and controlled by one individual. This means the person has unlimited liability for the business no matter the circumstance. On the other hand, a limited company has split ownership into equal shares between how many people are involved. This can help alleviate some strain and financial stress and leave you with less of a personal return at the end of each year.

Paying taxes as a sole trader

When it comes to tax and sole traders, things are done differently from a limited company.

As a sole trader you will need to make National Insurance Contributions (NICs). The amount you have to pay depends on the level of your earnings.Paying National Insurance contributions help you build up your state pension and benefits entitlement. If you’re a self-employed sole trader, your National Insurance costs are based around how much profit your business makes.

When it comes to tax, there are many rules and processes that go into being a self-employed, sole trader. A sole trader must pay tax on all their business profits. All taxable business profits are also subject to Class 2 and Class 4 National Insurance payments.

If you’re a sole trader in London, you can withdraw cash from your business without receiving any tax effect. Tax relief on interest and charges can be claimed if you’re a sole trader who has a separate personal banking account from their business account.

It’s worth noting that tax relief is given to sole traders on expenses exclusively for their business, meaning they won’t need to pay tax, or any tax they do pay will be reimbursed.

Another few points on tax as a sole trader are that when a sole trader sells their business or any assets, the monetary gain they receive will be taxed.

Read our sole trader vs limited company guide for more information.

Why do I need to fill in a self-assessment tax return?

The process of setting up and registering as a sole trader with HMRC is quite simple. Being a sole trader means that you are responsible for informing HMRC of your annual income every tax year. While standard employees get their national insurance and tax calculated for them, self-employed workers must complete a self-assessment every tax year so that HMRC can be informed and collect this owed money.

If you have earned less than £1,000, you may be exempt from this form, but it is worth checking out.

How to fill in your self-assessment

Here is a step-by-step guide in how to fill out your self-assessment tax return for and how to file it before the deadline of the tax year ends:

1. Collect your information. Locate all the relevant information regarding your income. This includes any details of earnings and business expenditure.
2. Fill in the form. When filling out the form, focus on the sections that are relevant to your own personal circumstance. If you're filling your form out online with your personal details, HMRC will remove any sections that are irrelevant to you.
3. Report your earnings. Alongside all your collected information, you must submit your yearly earnings. If you have a separate job - income from employment must be given as well as capital gains, rent, pension income, investment income and any redundancies.
4. Include tax-deductible expenses. Allowable expenses such as travelling, insurance, or marketing need to be added as these costs could be tax-deductible.

Do I need to register for VAT as a sole trader?

The answer to this question is in short, maybe. If you earn over £90,000 each year in annual turnover, you need to register for VAT.

If your business sells to other VAT-registered businesses, then you can register voluntarily. This can be a great way to reclaim any VAT that has been added within a sale. This is only if it suits your business and will not be suitable for everyone.

Do I need an accountant as a sole trader?

The answer depends on how much you know your money and tax issues. You are not required to have an accountant for your business accounts if you can do your own bookkeeping and tax return. But if you are unsure how much tax you need to pay or advice on all the expenses you can claim, then you’ll need someone hands on who knows accounting and tax to advise you. You can also forgo an accountant in your first year of business but to keep track of the annual accounts showing the flow of cash, expenses, and benefits after your business has grown you might need an accountant. The best way to keep track of the money flow is to have a separate bank account for your personal account and business transactions.

What are the main advantages of being a sole trader?

Apart from the total control and flexibility that comes with sole trading, there is a potential to earn more longer term, through running a business and the tax savings you can make. Keeping all your business's profits, setting up your own business is also relatively easy because you pay less to get things goings and you’re awarded with less administrative headaches.

Unlimited liability

A business being run by a sole trader is not recognised as a separate legal entity, so the sole trader is personally liable for the business's debts and liabilities incurred. If the business does not take off or fails with debts, you will lose your income and will have to pay for the debts using personal assets that are not connected to the business. With unlimited liability you can lose valuable personal assets like your home or declare bankruptcy.

Tax limitations

If you are self-employed, you could pay more tax from your profits than those in limited companies would. For example you’ll pay income tax on your earnings whereas alimited company director can pay themselves dividends, which are generally taxed at a lower rate.

Problems with securing funding

The sole trader structure is considered more risky for banks and other financial organisations that you might want to access funds from. If you want to borrow money to raise your capital, then the accounting transparency that is associated with a limited company. but not a sole trader, will affect the amount of cash you may be offered by banks or financial institutions. The terms offered for you to access the loan might also differ to those offered to limited companies.

Sole traders might be able to access fixed rate loans but may not be able to access long-term finance loans or government schemes that are available for others. Since you cannot secure investments with shares or other financial securities, it’s always hard to secure large amounts of funding with good terms that can help grow your business.

More responsibility

While you might employ people to help you run the business all the big responsibilities and decisions rest on your shoulders. With no one else to brainstorm or bounce ideas off, you can be lonely and in need of further support.