If you’re a self-employed person running your own business, you automatically become a sole trader. Some business owners and franchisees will choose to remain sole traders in the long term, while others will choose to set up a limited company or some other kind of legal enterprise. But what does it really mean to be a sole trader? This article breaks down the basics.
Like anything, operating as a sole trader comes with advantages and disadvantages. We’re going to take you through all the key information, including what a sole trader is, what is required to be a sole trader, and what the benefits (and drawbacks) of sole trading are.
Business basics can feel confusing when all the terms are new to you, but when you break things down, you’ll quickly figure out where you stand and be able to determine the best moves for you and your business.
What is a sole trader?
As mentioned above, you will automatically be considered a sole trader if you run your own business as an individual. Once your individual taxes have been paid, you’ll keep all of your business’s profits. However, you will also be liable for any losses.
70% of sole traders enjoy being small and aren’t pushing for growth, and 62% say the benefits of being a sole trader massively outweigh those of being a part of a larger business [London Loves Business].
How do you become a sole trader?
Becoming a sole trader is a simple process, as this option is the default for individuals working for themselves. If any of the following apply to you, you’re a sole trader:
- You’ve earned more than £1,000 from self-employment between 6th April 2020 and 5th April 2021.
- You need proof that you’re self-employed (you might need this, if, for example, you’d like to claim tax-free childcare).
- You want to make voluntary Class 2 National Insurance payments to help qualify for benefits.
Sole traders should complete four simple set-up steps...
1. Be 100% certain that self-employment is the right option for you
Running your own business can be very hard work, and self-employment will require you to:
- Take responsibility for both successes and failures
- Juggle several customers at the same time
- Decide how/when/where you’d like to work
- Hire employees
- Provide the majority of equipment required
- Sell goods or services to make a profit
Other options to consider at this point include:
- Setting up a private limited company or a public limited company
- Becoming a partner in a business partnership or a limited liability partnership
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2. Decide on a name for your business (unless you’re becoming a franchisee!)
If the business you’re about to start running doesn’t have a name already, now’s the time to lock one down. Once you’ve settled on a name, consider registering a trademark for it. That way, other businesses won’t be able to take advantage of your name at a later date. Sole traders must follow certain rules when trademarking the name of their business:
- No inclusion of misleading phrases - Sole traders can’t use phrases like “limited”, “LTD”, “limited liability partnership”, “LLP”, “public limited company” or “PLC”, as these aren’t an accurate representation of the legal status of a sole trader.
- No inclusion of offensive words or phrases - Nothing that’s considered offensive can become your official trademarked name.
- Nothing too similar to an existing trademark - Your name must be distinct and different enough from existing registered trademarks.
Register for Self Assessment
You can register for Self Assessment via the government website. At this point, you can also apply for a National Insurance number if you don’t already have one. From a legal standpoint, you’re required to register with HMRC before 5th October in your second tax year of self-employment. The tax year runs from 6th April to 5th April every year.
If you don’t register yourself in time, you risk getting fined for between 30-100% of the tax that’s owed. You may also be charged interest on your tax bill, as well as a daily penalty. You can avoid a penalty if you’re able to prove:
- You have a reasonable excuse for missing the deadline
- You didn’t deliberately miss the deadline
- You informed HMRC as soon as possible
Before you register for Self Assessment, you must understand the responsibilities that come with operating as a sole trader. Sole traders must:
- Keep all records of business sales and expenses
- Send a Self Assessment tax return every year
- Pay income tax
- Register for VAT if earning over £85,000
Being a sole trader allows me to be flexible and more agile. Staying small gives me full control of how I turn my passion into a business. Being able to stamp your own personality onto your product is something my customers really appreciate.
—Leon A. Hamilton, owner of Hamilton Dessert Co
>> Read more:
What are the benefits of operating as a sole trader?
- Flexible working - Without a boss, you can set hours that work for you.
- Independence - As a sole trader, you only answer to yourself. For people who enjoy being in control, the value of this independence is second to nothing.
- Job satisfaction - You can shape a role that suits you perfectly, and find maximum satisfaction in the process.
- Creative freedom - When you want to change direction or try something new, there’s far less hassle involved.
- Lower admin costs than other arrangements - As the default option, sole trading comes with the smallest amount of admin effort and cost.
- Privacy - The financial reports of sole traders remain private, and there’s no obligation for a sole trader to register with Companies House, so maximum privacy is available.
- Profits are yours - As a sole trader, you’re responsible for all of your losses, and you keep ALL of your profits after tax.
What are the drawbacks to operating as a sole trader?
- Lack of employee benefits - In a large company, your role will generally come with a host of different benefits including things like a pension scheme. For sole traders, this is of course not the case.
- Financial instability - There’s no guaranteed wage at the end of the month for sole traders.
- Full liability - As a sole trader, you keep all your profits, but you’re also responsible for ALL of your losses.
- Long hours - Particularly in the first few years, when building up a solid client base, sole traders might struggle to work consistent or sociable hours.
Handling the Self Assessment tax process and accompanying requirements - The tax process must be handled entirely by the sole trader, or the cost of an accountant/accounting software must be covered by the sole trader.
What are the tax benefits of being a sole trader?
The tax free allowance for sole traders is £12,500. You can deduct expenses through your Self Assessment return, but you will only be able to claim relief on items deemed a necessity for your business. Allowable expenses include:
- Goods bought for resale
- Vehicle and travel expenses
- Rent, power and insurance costs
- Phone bills
- Office stationery
- Any interest on loans
- Bank and credit card charges
- Accountancy and legal fees
- Training courses related to your business
- Subscriptions to professional societies
- Protective clothing, if required
Once you reach a certain point income threshold, it’s worth strongly considering setting up as a limited company. As a sole trader, you’re taxed on all your profits. As a limited company, you’ll instead pay corporation tax, which is capped at 18%. You can then pay yourself dividends, and keep more of your earnings.
Are you ready to operate as a sole trader?
We hope this rundown of the basics on all things sole trading has helped you understand more about the concept. Hopefully, you now have a solid grasp on the process, and can carefully consider whether beginning to operate as a sole trader is the right business move for you. To research specific franchise investment opportunities, browse Point Franchise’s directory.
Lily Sweeney, Point Franchise ©