The label sole trader describes your business structure rather than how you are employed. You can officially call yourself a self-employed sole trader or, unofficially, a self-employed owner of a limited company. Sole traders don’t pay tax via PAYE.
A sole trader is a self-employed worker who is the sole owner of the company. They should ensure their work practices fall within the definition of “self-employment” and watch out for the “off-payroll working” legislation that governs the distinction between self-employment and employment.
Let’s look at the distinction between sole trader and self-employed to help you make an informed decision about the best business structure.
What is a sole trader?
A sole trader is a self-employed worker (known also as a freelancer or contractor) who is, as the name suggests, their own boss and the sole owner of their business.
Legally, as a sole trader, any debts the business might accrue, as well as all the profits after tax and national insurance contributions (NIC), are yours.
Hiring an accountant to do your sole trader accounts saves you time and resources. Frequently, your accountant’s expertise and advice on compliant tax planning, structuring, and reporting will cover your accounting fees, which are an allowable expense.
Sole trader business structure
A sole trader is the simplest business structure to set up and run. Also called a sole proprietorship, this legal entity gives one individual responsibility for the company and entitlement to keep all profits once taxes have been deducted.
Each type of business structure, whether sole trader/self-employed, limited company/self-employed, or a partnership, differs in the volume of paperwork, the tax you’ll pay (including NIC), how profits are distributed, and personal liability for the business’s losses or debts.
Sole traders must register with HM Revenue & Customs (HMRC) and submit a self-assessment tax return by 31 January annually, paying any tax owed by that date, too (and by 31 July that year, depending on the business’s profits). Their accounts must be scrutinised since these figures make up their tax return. Late or non-payment of tax by the due date can result in a fine.
Benefits of being a sole trader
There are advantages to setting up as a sole trader:
- Cost: Low registration and start-up costs; sole traders avoid the costs associated with incorporation.
- Control/flexibility: Sole freedom to decide to meet market trends without consultation and keep profits after tax.
- Simplicity: Ease of setting up and dissolving the business; sole traders register with His Majesty’s Revenue & Customs (HMRC) and submit a self-assessment tax return.
- Privacy: No need to register with Companies House or submit company accounts as such.
- Legal: simpler because the company and its owner are one and the same.
- Rights: like a limited company, sole traders can employ one or more employees; the same rules apply if you pay people via PAYE or hire a self-employed freelancer.
Drawbacks of being a sole trader
There are disadvantages to setting up as a sole trader:
- Unlimited liability: With no legal distinction between the owner and the company, they are personally responsible for losses and any debts.
- Business continuity: The owner and company are one entity; you’d have to organise the transfer of assets to the new owner.
- Capital investment/loans: it’s more difficult for sole traders to obtain loans and capital investment.
- Sick leave: Unable to subscribe to group income protection business insurance. Sole traders depend on state benefits or individual income protection.
- Work-life balance: It can be harder to take time for a break without someone to take charge when you’re away.
- Growth: Capacity might hinder their ability to take on new work; hence, some sole traders convert to a limited company or limited liability partnership (LLP) to realise their growth plans.
What does self-employed mean?
The label self-employed means that you work for yourself and are a small business owner rather than another business employing you.
As a sole trader, there’s no legal distinction between you and your company; legally and financially, you are one entity.
A self-employed owner of a limited company or an LLP is legally separate from their business; limited liability protects their personal assets.
In terms of tax, self-employment makes you responsible for keeping your own books and accounts, complying with the self-assessment process, and running your organisation in accordance with UK business law. You will pay income tax and NICs through self-assessment rather than PAYE.
As a sole trader/self-employed worker, you are legally required to inform HMRC within three months of becoming self-employed. You could face a penalty if you fail to do so.
A limited company registers with Companies House and must have at least one director. The company pays corporation tax rather than personal tax through self-assessment.
When you run your own small business as a limited company, you submit company accounts to HMRC and Companies House. Directors may take dividends as part of their salary, which are declared through the self-assessment process.
So, the legal structure for a self-employed person (contractor or freelancer) can be a sole trader, limited company, or partnership.
A business partnership works in a similar way, but in this case, two or more workers own the business.
What is classed as self-employment?
The classification of self-employed (rather than employee or worker) is dependent on your level of independence. Cases involving atypical workers in the “gig economy” include the landmark Uber drivers’ case at the Supreme Court.
The IT contractor market has experienced disruption by “off-payroll working” rules (IR35), making the contractor/self-employed person and the employer/commissioner of the work jointly and severally liable for backdated national insurance and income tax as well as penalties and fines if operating outside the legislation.
HMRC’s off-payroll working rules for clients, workers (contractors), and their intermediaries have caused uncertainty in the contractor/self-employed market. To ensure awareness of the rules, you can take a free online “IR35 test” or seek advice from an accountant with expertise in the self-employed/contractor market.
Indicators of true self-employment include:
- In charge of how your business is run;
- Risking your own money in the business;
- Responsibility for the business’s losses and profits;
- Providing the main equipment related to your job;
- Sending a substitute to carry out commissions and paying them at your own expense;
- Responsibility for correcting unsatisfactory work at your own expense;
- Working for multiple people/companies concurrently.
You can be employed and self-employed at the same time; e.g., you may work for an employer during the day but run your own part-time business in the evening.
Benefits of being self-employed
Creative freedom: Once established, you can be more selective and choose the jobs that pay better and the clients who pay on time.
Control over how, where, and when you work: You may work from anywhere, in the evening, overnight, early morning, or weekends.
Higher earnings potential: You needn’t be exclusively self-employed; you could be employed part-time and run your own business in the evenings. For retirees, self-employment can provide stimulation and a pension boost.
Self-pride: Successes are down to you; meeting deadlines, achieving goals, and developing a good reputation brings job satisfaction.
Variety: No day will be quite the same; you can orchestrate your own workflow.
New skills: Working on different projects with several clients will develop your interpersonal and professional skills.
Drawbacks of being self-employed
Self-administration: Whatever its legal status, all companies must accurately record sales/takings and purchases/business expenses. The self-employed must calculate, file, and pay tax and NICs to HM Revenue & Customs. Business administration can be time-consuming, and late filing or payments and errors attract penalties and fines (hence, many businesses hire an accountant to do it for them).
Job security: You’re responsible for generating business so that you have a reliable source of income.
Registration: You are responsible for registering with your regulatory body (if your trade has one) and ensuring that you have business insurance (if applicable).
Juggling responsibilities: Running your accounts, meeting deadlines, carrying out work commissioned, and actively following leads and business opportunities.
Fewer statutory benefits: You won’t have the same basic employment rights (e.g., sick pay, annual and/or maternity leave, minimum pay, working time regulations, union membership, etc.)
Pension: You’ll need to make your own private pension arrangements.
Do sole traders and self-employed individuals pay the same taxes?
Sole trader businesses only need to register with HMRC as self-employed, submit tax returns, and pay tax and NICs rather than being taxed via PAYE. Members of a sole trader partnership are also classed as self-employed.
Income tax
Income tax bands are tapered so that the same rate of tax is not paid on the entire sum.
Personal allowance: up to £12,570
Basic rate: £12,570–£50,270 at 20%
Higher rate: £50,271–125,140 at 40%
Additional rate: Over 125,140 at 45%
For example, if your gross profit was £25,000, you’d pay 20% tax on the sum over the personal allowance (£2,484.20).
National insurance contributions
Self-employed national insurance contributions go towards state benefits (e.g., sickness benefits, universal credit) and contribute to your state pension.
While employees pay tax and NICs through PAYE, self-employed workers pay NICs after their profit reaches £6,725 or more per annum. They then pay £3.45 (Class 2) per week on profits on or over £12,570 and pay Class 4 NICs at 6% (between £12,570 and £50,270) and 2% on anything above.
Differences between being a sole trader and self-employed
The label sole trader describes your business structure rather than how you are employed.
If you’re a sole trader, you can also call yourself self-employed and employ people. A limited company owner is technically both an employee of the company and self-employed. However, for tax purposes, a limited company owner is not self-employed. The company pays corporation tax and employers’ NICs and pays its employees via PAYE.
Should I be a sole trader or self-employed?
A sole trader business owner is also self-employed. If you’re self-employed, then it’s a choice between a self-employed sole trader, a limited company, or a partnership business structure.
The question is more about business structure preference. The argument is not actually concerned with sole traders vs. self-employed.
For simplicity, a sole trader structure might suit you better (but you are also personally 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 (and also better protect your personal assets), then the limited company business structure might be more suitable.
As the exclusive owner of your business, you have complete control over it, but sole trader responsibilities are no less concerned with compliance. If you register your business as a company with limited liability instead, you won’t lose control over your business, working hours, or how your business makes its profit.
FAQs
Can you have employees as a sole trader?
Legally, there’s no reason why a sole trader business shouldn’t hire employees.
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. Public liability insurance may also apply depending on your trade.
Like a limited company, sole trader employers are obliged to register for PAYE with HMRC 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 online. HM Revenue will issue PAYE and Accounts Office reference numbers, which can take up to five working days.
Can I pay myself a wage as a sole trader?
Sole traders pay themselves by drawing money out of the business; it’s better to run a separate business bank account. Splitting personal finances and business income and expenditure increases transparency.
With no legal distinction between you and your business, sole traders receive the income, pay any expenses, pay income tax and NICs, etc. Although a self-employed individual has ten months to pay any tax owed, they are advised to operate a separate bank account that receives a percentage (between 25% and 45%) of monthly earnings, ready to meet their tax deadline on January 31.
Can you be employed and self-employed?
You can be both self-employed and employed. Self-employed income is reported, and you pay your own taxes via self-assessment, while your employer will deduct tax from your salary through PAYE.
If you call yourself self-employed, you must work for more than one client. It’s an offence to “collude” with an employer who might (according to HMRC’s reasoning) want to break employment law by avoiding paying tax, NICs, and holiday pay.
To avoid non-compliance with HMRC’s “off-payroll working” rules (IR35), free online sources help you work out whether you really are “self-employed” or whether you are working as a disguised employee.
Conclusion
Sole trading is a way to run your own business as a self-employed person, freelancer, or contractor. A sole trader is a self-employed person who is the sole owner of their business. Arguing sole traders vs. self-employed misdirects us somewhat.
Sole trader businesses don’t need to register with Companies House but must register as a sole trader with HMRC and pay tax through self-assessment.
It’s their legal responsibility to keep accurate accounts that are up to scrutiny; these are used to fill out a self-assessment tax return.
All business profits after tax are retained by the sole trader. However, this type of business entity also means personal liability for any debts or losses incurred by the business.
Since you don’t need to file a company tax return with HMRC, submit company accounts to Companies House, or pay corporation tax, your accounting may seem more straightforward, but are you certain that your sole trader business is 100% compliant and tax efficient and you’re claiming all the tax reliefs and allowances available to you?
