The label sole trader describes your business structure rather than how you are employed. You can call yourself a self-employed sole trader or a self-employed owner of a limited company.
The difference between self-employed and sole trader is that “Self-employed” is only a label. This means that you are not employed by another company or person and that you do not pay tax through PAYE. A sole trader is a self-employed worker and is the sole owner of their business.
On the subject of being self-employed, you should make sure that you really are what falls within the brackets of “self-employed”; watch out for the “off-payroll working” legislation that governs the distinction between being employed and self-employed.
In order to decide which business structure is right for you, we will talk you through the differences between being a sole trader vs self employed.
Read on to find out more…
What is a sole trader?
A sole trader is a self-employed worker (who may also be known as a contractor) who is, as the name suggests, the sole owner of their business.
The sole trader business is legally yours, but that goes for any debts the business might accrue as well as all the profit after you have paid taxes.
Having an accountant to do your sole trader accounts can be in value in saving you time and resources.
Sole trader business structure
A sole trader business is the simplest business structure to run. Also called a sole proprietorship, this business structure means that one individual is responsible for the business and entitled to keep all profits once tax has been deducted.
With no legal distinction between the individual and company, a downside often mentioned in relation to this sort of business structure is that as a sole trader you are also personally responsible for any losses the business may incur.
This is called unlimited liability, whereas if you run a limited company then you have limited liability, which means you and the business are seen as separate entities in law.
Each type of business structure, whether sole-trader/self-employed or limited company/self-employed or a partnership, differs in the amount of paperwork you have to complete, the tax you will have to pay (including national insurance), the way profits are distributed, and personal responsibility if the business makes a loss or gets into debt.
There is an upside to being a sole trader, however, because you are free to make all the decisions for the business, plus it is relatively easy to establish and then close down a sole trader business.
Sole traders must register with Her Majesty’s Revenue & Customs (HMRC) and submit a self-assessment tax return. They must pay any tax owed by 31 January every tax year (and in July of the same tax year depending on the profits of the business).
As you must submit a self-assessment tax return you must also keep accounts that are up to scrutiny by the tax authorities. You must pay what you owe by the due date or you could be fined.
But you don’t have to submit company accounts as such. A sole trader business can employ one or more employees, but the same rules apply to a sole trader as for a limited company employer if they pay people through PAYE.
What does being self-employed mean?
The label self-employed means that you work for yourself and run your own business rather than being employed by some other business.
Being self-employed in terms of tax, means that you are responsible for keeping your own accounts, submitting a tax return, and for the success of your business.
You pay tax through self-assessment rather than paying tax as you earn (PAYE) if you are a sole trader self-employed person, or if you’re self-employed and a limited company then you will submit company accounts to HMRC and to Companies House.
You also need to pay corporation tax, and may take dividends out of your business as part of your salary.
So, the structure of your business as a self-employed person (or contractor) can be sole trader, limited company or partnership.
As mentioned above, a sole trader business is a business where you and the business are not legally defined – legally and financially you are one entity.
A business partnership works in a similar way, but in this case, two or more workers own the business.
A self-employed owner of a limited company or a limited company partnership is separated in law from their business, so that the personal assets of the individual/s are separate from the business.
A limited company has to be registered with Companies House and needs to have at least one director. You have to pay corporation tax rather than personal tax through self-assessment process.
You must tell HMRC that you are self-employed within three months of the end of the calendar month in which you became self-employed. You could face a penalty if you fail to do so.
What is classed as self-employment?
Whether you are classed as self-employed (rather than an employee or a worker) depends a lot on the level of independence you have.
Recent cases involving the status of people working in the “gig economy” has been the subject of tribunals and courts, notably in the case with Uber drivers at the supreme court.
The IT contractor market has been all but decimated by the “Off-payroll working” rules (IR35) which have recently made the contractor/self-employed person and the employer/commissioner of the work, jointly and severally responsible for backdated national insurance and tax as well as penalties and fines if caught falling foul of the legislation.
HMRC’s Off-payroll working rules for clients, workers (contractors) and their intermediaries has caused a lot of uncertainty in the contractor/self-employed market, so make sure you are aware of the rules, by doing one of the free online “IR35 tests” or by seeking advice from an accountant with expertise in the self-employed/contractor market.
Indicators that you are truly self-employed include that you:
- Have the final say in how your business is run
- Risk your own money in the business
- Are responsible for losses as well as profits of your business
- Provide the main items of equipment to do your job
- Could send a substitute or are free to hire other people to do the work you have taken on and pay them at your own expense
- Are responsible for correcting unsatisfactory work in your own time and at your own expense
- Have the ability to work for other people/companies at the same time as providing services for another person/company
You can be employed and self-employed at the same time. For example, you may work for an employer during the day but run your own part-time business in the evening.
Differences between being a sole trader and self-employed
The label sole trader describes your business structure rather than how you are employed.
You can call yourself a self-employed sole trader or a self-employed limited company owner, as the label self-employed means that you are not employed by another company or person and that you do not pay your tax through PAYE (though you may run your own payroll; sole traders can employ people).
Should I be a sole trader or self-employed?
If you are a sole trader then you are self-employed. If you are self-employed, then it’s a choice between a self-employed sole trader, limited company, or partnership business structure.
The question is more about how you prefer to structure your business.
If you prefer to keep it simple, then a sole trader structure might suit you better (but you are also 100% liable for any loss or debt, you may pay more tax and you will have to pay Class 2 and Class 4 national insurance).
If you can handle a bit more complexity in terms of paperwork (while also better protecting your personal assets), then the limited company business structure might suit you better.
You have complete control over your business if you are a sole-trader, but you can still have control over your business and working hours and and sell goods or services for a profit if you register your business as a limited company instead.
Can you have employees as a sole trader?
Sole traders can employ people; there is no need to be a limited company to employ people. While the label “sole trader” suggests someone is working alone, legally there is no reason why a sole trader business should not employ people.
If your sole trader business employs people who are not members of your immediate family or are not based abroad, you should take out employers’ liability insurance.
To set your sole trader business up to employ people is the same as for limited companies. You must register as an employer with HMRC and register for PAYE, which should be done before the first payment of salary to the employee, but no more than two months before the first payment.
Sole traders can register for PAYE by using this online form. After registering as an employer, HMRC will issue PAYE and Accounts Office reference numbers, which will be necessary to enrol for PAYE online. This could take up to five working days.
Can I pay myself a wage as a sole trader?
Sole traders don’t receive a salary or wage exactly but pay themselves by drawing money out of the business. It is better to have a separate business bank account for your sole trader finances.
Without any legal difference between you and your business, as a sole trader you receive the income, pay any expenses, pay your tax and national insurance, etc. Even though as a self-employed person you have ten months to pay any tax you might owe, it is important to make sure you don’t count all the money as your own, but aside enough money to pay your tax by January 31 each year.
The following amounts are what is recommended a sole trader should put aside to pay their tax and national insurance:
Drawings per annum % set aside for tax:
- up to £50,000 25%
- up to £100,000 40%
- between £100,000 and £150,000 45%
Can you be employed and self-employed?
You can be self-employed and employed at the same time.
For example, you might work full-time as a lecturer and then run an online handknit shop to earn extra income.
Self-employed income will have to be reported and paid through self-assessment, while your employer will deduct tax from your salary through PAYE.
If you call yourself self-employed but only work for one company (e.g. you have one major client), then be careful. You are not allowed to “collude” with an employer who might (according to HMRC’s reasoning) be avoiding paying your tax and national insurance contributions or awarding you your rightful employment rights.
Beware falling foul of HMRC’s “off-payroll working” rules (IR35). You could use one of the free, online sources to help you work out whether you really are “self-employed” or whether you are working as a disguised employee or you could contact an accountant who is specialist in this area.
Sole trading is a way to run a business as a self-employed person or contractor. A sole trader is a self-employed person who is the exclusive owner of their sole trader business.
Sole trader businesses don’t need to register with Companies House, but because sole traders are self-employed they must register as a sole trader with HMRC and pay tax through self-assessment.
Therefore, accurate accounts that are up to scrutiny must be kept to be able to fill out your self-assessment tax return.
All business profits after tax are retained by the sole trader, but you are also personally liable for any debts or losses the business may incur as there is no legal distinction between the two entities of business and individual business owner when you are a sole trader.
The upside is that you do not have to submit a company tax return to HMRC or submit company accounts to Companies House or pay corporation tax, so bookkeeping may seem more straightforward than for a limited company.