What is a sole trader? It simply means being self-employed, although sole traders can also have employees.
Being a sole trader 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 (ie one that is unlikely to build up big debts), you probably needn't worry too much.
However, if you're likely to build up significant business debts, it might be better to form a limited company (ie 'incorporation'), which protects your personal finances.
Why become a sole trader?
Registering as a sole trader is quick, easy and involves no cost, while preparing sole trader accounts is usually quite straightforward. Sole traders can employ people and become a limited company ('incorporate') later on, if they want to.
Setting up and running a limited company requires more admin than being a sole trader, plus you (or a formation agent) must register your new company at Companies House.
(You can use a sole trader versus limited company tax calculator to estimate your take home pay with either type of business, simply by inserting an estimate of your annual profit.)
Although anyone can become a sole trader, you might need a licence or permit from your local authority depending on the type of business you plan to set up. Seek advice if you're not sure.
How to register as a sole trader
You must register your sole trader business with HM Revenue & Customs (HMRC) as soon as possible - otherwise you could be fined to the equivalent of 100% of the tax due, as well as having to pay the tax itself. This is true even if you are only running your sole trader business on a part-time or casual basis.
Many entrepreneurs start their business off part-time - to test the water or while the business grows enough to generate enough income. Some continue working as an employee during these early days so that they have a salary to fall back on.
In these cases, you will still need to register with HMRC if your employment status indicates you are self-employed for some or all of your work.
The easiest way to register as a sole trader is through the HMRC Online Service or their 'Newly Self-Employed Helpline' on 0300 200 3504. You will need to provide:
- your name;
- your date of birth;
- your address;
- your telephone number;
- your National Insurance number;
- the business' start date;
- the name and type of business;
- 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, complete the HMRC form 'Register if you're a self-employed sole trader'. It will then need to be printed and posted to HMRC.
As a sole trader business, 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 pay National Insurance contributions (NICs). NICs are collected at the same time as your tax via self assessment.
If your annual profits exceed £12,570, you'll have to pay Class 4 NICs at 6% on profits up between £12,570 and £50,270; and 2% on annual profits above this figure. You pay this with your income tax and the figure is calculated from your self-assessment tax return. [Note: prior to the 2024/25 tax year, both Class 2 and Class 4 NICs were payable.]
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 return each year.
If, you employ people as a sole trader, you need to collect income tax and NICs from them and pay these to HMRC. You'll also need to operate a PAYE (Pay As You Earn) payroll scheme and enrol eligible employees into a pension scheme and contribute towards it.
If you expect VAT taxable turnover to be more than £90,000 a year from 1 April 2024 (previously £85,000), 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.
Running a business of any form will involve some risk. You should protect yourself where possible by making sure you have suitable business insurance.
HMRC email updates, videos and webinars for the self employed
Use this self-paced e-learning tool from HMRC to help you get to grips with tax when starting your business. Covering subjects including registering your self employment, what records you should keep and online self-assessment, modules can be completed at your own pace or repeated if necessary.
