Becoming a sole trader

Being a sole trader (‘self-employed’) involves some personal financial risk. Sole traders must pay their debts if their business fails. If you’re thinking of starting up a low-cost business, you probably needn’t worry too much.

However, if you’re likely to build up significant business debts, you’re probably best having the personal financial protection offered by forming a limited company.

Sole trader versus limited company

Setting up and running a limited company requires more administrative effort than being a sole trader. Setting up a sole trader is quick, easy and involves no cost. You can employ people and become a limited company (‘incorporate’) later on, should you wish.

Although anyone can become a sole trader, you might need a licence or permit from your local authority for the type of business you plan to set up. Seek advice if you’re unsure.

Informing HMRC about your new business

Within three months of your start date, you must let HM Revenue & Customs (HMRC) know you have become a sole trader/self-employed – otherwise you could be fined £100 for not registering your business.

The easiest way is to call the HMRC ‘Helpline for the Newly Self-Employed’ on 0845 915 4515. The operator will ask you: your name; date of birth; address; telephone number; National Insurance number; start date; name and type of business; and whether you’re a sole trader or working with a partner. The process is quick and easy if you have the information to hand.

Alternatively, you can register online or download and complete the HMRC form ‘Becoming self-employed and registering for National Insurance contributions and/or tax’. It will then need to be sent to the National Insurance Contributions Office.

Tax and National Insurance for sole traders

As a sole trader, you pay income tax on any business profits. You (or your accountant) must fill in a self-assessment tax return each year, detailing your income and expenses.

You'll also have to make flat-rate Class 2 National Insurance contributions (NICs) throughout the year (£2.40 a month). Setting up a direct debit can make payment more convenient.

If your annual profits exceed £5,715, you’ll also have to pay Class 4 NICs. You pay this with your income tax and the figure is calculated from your self-assessment tax return. You must keep detailed financial records for your business, as well as proof of any expenses (eg receipts, invoices, utility bills, etc). Both will be invaluable when it’s time to fill in your tax returns each year.

If, as a sole trader, you employ people, you must collect income tax and NICs from them and pay these to HMRC. You’ll need to operate a PAYE (Pay As You Earn) payroll scheme, too. If you expect to turn over more than £70,000 a year, you must register for VAT, charge it to your customers and pay it to HMRC. If you are VAT-registered, you can reclaim the VAT you pay to your suppliers.