With more and more people working from home these days, the idea of cutting ties with companies and working for oneself has become ever more appealing. Indeed, some 4.6m people currently do so, one can assume in an attempt to have a better work/life balance and to be fully in charge of their own destiny.
However, before taking the plunge and branching out on your own, it’s important to know the legalities of so doing.
When setting up the business, you must decide whether, as a sole trader, you (the business owner) and the business itself are considered one legal entity. That being so, you would be entitled to all profits after tax.
A sole trader is an exclusive owner of their business as well as being self-employed, and the term ‘sole trader’ defines the business structure that is in place.
As the owner of the company there is the option to employ others, but to remain a sole trader, it is imperative to register as self-employed with HMRC to pay tax through the Self-Assessment process.
Are you a ‘sole trader’ or ‘self-employed’?
In simple terms, being ‘self-employed’ relates to your way of working, whereas being a ‘sole trader’ relates to the structure of your business.
You cannot claim holiday pay, sick pay or be paid for days not worked if you are self-employed. Essentially, you are making the decision as to when you work, for how long and what type of work you will undertake.
Furthermore, it’s vital to understand from the outset that for tax purposes, you will be fully responsible for all taxes being paid on time and via the HMRC’s Self-Assessment programme. It may be of benefit to employ an accountant to take on this work for you, though the more accurate records that are kept, the easier the entire process becomes.
As a self-employed person, it is possible for you to choose to be either a sole trader, business partnership or limited company. The difference is the definition of being a ‘sole trader,’ which makes you the sole owner of the business eg. for legal and financial purposes, the owner and the business are one entity.
As a ‘partnership,’ the business is owned by two or more people.
A ‘limited company’ is entirely separate from the owner, meaning that their personal finances are protected from the outset. All limited companies must have at least one director in place, and must also be registered at Companies House in London.
By definition, sole traders are self-employed because they run their businesses by themselves, but you do not have to be a sole trader to be self-employed as you can choose to be part of a business partnership or a limited company.
For example, freelance writers are generally both self-employed and registered as sole traders. A hairdresser that works in a salon on a self-employed basis, effectively ‘renting a chair,’ is responsible for paying their own taxes. The salon owner is not.
A plumber that runs their own plumbing business and is the sole owner can be classed as both self-employed and a sole trader. Business consultants running their own small business can register as a limited company, but be self-employed.
Working for oneself comes with inherent risk, so from the outset it may be prudent to consider buying appropriate insurance to guard against such risk. Dependant on which sector you choose to work in, there are a number of different insurances to give the once-over; Professional indemnity, self-employed insurance, office contents and/or public liability insurance.
It isn’t a legal requirement to have any of the above insurances as a self-employed person, however, should you employ any staff, then Employers’ Liability Insurance is a must.
As a self-employed person, it is incumbent upon you to inform the HMRC of your intentions within three months of the start of trading. Each year, filling out a Self-Assessment tax return is a laborious but necessary task, as this ultimately denotes how much tax and National Insurance you will need to pay.
Were you to decide to also start a limited company, then it is imperative to register with Companies House.
Sole Trader 5 Advantages
There absolutely are advantages to be had by being a sole trader. Not least the business structure. Below are five other reasons why you might consider branching out on your own:
- Low costs/Higher profits: As a sole trader, normally – although not always – there are no employees, or certainly very few. Therefore, the lack of a ‘wage bill’ is a clear plus point. Very little up front cash is required to begin trading, and registering with HMRC is free, so there is a cost saving to be made there also. Once Tax and National Insurance contributions have been taken care of, any profits made by the business are yours to keep. Were you to form a partnership, for example, then those profits would have to be shared, as they would if you were to set up as a limited company. A limited company would also need to be formed at Companies House, thus incurring associative costs.
- Control: Setting up as a sole trader is much less time consuming that doing so as a limited company. Let the HMRC know the date you wish to begin trading, and register as a self-employed person – this can be done online – if you expect to earn more than £1,000 from April 6 to April 5 of the following year. As a sole trader, you retain full control of your business. In practice, and depending what sectors you serve, that means you’re able to concentrate fully on the needs of the business and/or its customers/clients, without the fear of interference from others.
- Be your own boss: Aside from the set-up process being much easier as a sole trader, there is also the added advantage of having less paperwork to deal with. For example, as long as you keep your records up to date, then you only need spend one day per month sending invoices, and another day to ensure payments have been completed and these have been entered correctly onto a spreadsheet. The rest of your time can be spent running your business how you see fit – without the decision-making processes commonly encountered in other businesses, such as partnerships for example.
- Privacy: As a sole trader, your personal information as well as the details of your business can be kept private if you so wish. You are not obliged to register your business at Companies House, which you will be required to do if you are a limited company. Moreover, by registering as the latter, which you will do at Companies House, your information becomes a matter of public record. This will include, for example, the limited company’s accounts, as well as full details on the business, its directors and shareholders.
- You can change your mind: Starting off as a sole trader certainly has its advantages, particularly if it’s a scalable business. It means that a move to a bigger, limited company may be possible at a later date. Indeed, those who decide to move from being employed to self-employed arguably take the sole trader route initially. Then, if a change of business structure is required and necessary – for example if income increases significantly – it could be more beneficial from a tax perspective to begin running the business as a limited company, which can be easily done. Were you to begin as a limited company from the outset, then there are formal processes involved should you wish to close the company in order to operate as a sole trader.
Sole Trader 5 Disadvantages
As with most things in life, there are always two sides to every coin, meaning that setting up as a sole trader also has its disadvantages. Below are five reasons that may stop you from contemplating making a leap of faith in order to work for yourself:
- Liability: This is where being part of a limited company has its advantages as, the owner and the business are separated and seen as two different entities. As the law in the UK states, sole traders are not a separate entity from their business and, as a result, their liabilities are unlimited. In simple, practical terms, what this means is that the entire business debt and liabilities are yours, and yours alone. It is a risk financially to work as a sole trader, because you have no protection whatsoever for your assets and personal finance.
- Finances: Continuing with the theme of money, sole traders can often be considered to be more of a financial risk than, for example, a limited company. As a result, banks are usually far more cautious when it comes to the business of lending. Therefore, fund raising as a sole trader can be fraught with difficulty (albeit sole traders normally have a low set-up cost). When it comes to paying taxes, a limited company director can work the system in order to maximise income. That’s an area where a sole trader has much less flexibility to have the system work to his/her benefit. From a tax perspective, as of 2020/21, a sole trader’s tax free personal allowance stands at £12,500. Should the business make more money than that, they are taxed accordingly; Between £0 and £50,000 earned, a basic rate of 20% tax will apply. A higher rate of 40% only comes into effect on income from £50,001 to £150,000, and any earnings over that higher amount will garner a tax rate of 45%.
- Decision-making: It is right to suggest that as a sole trader there is a certain amount of freedom in the decision-making process. You have full responsibility for the success or failure of your business and can’t pin the same on anyone else. Every decision that is made is yours and yours alone. That level of control should be seen as a positive aspect, however, the stress that it can sometimes cause can also result in undue pressure which, in turn, arguably leads to poorer decision making.
- Work-Life balance: It is essential for every worker, sole trader or otherwise, to have a good work-life balance, however, in practice, this really isn’t possible for the former. Working long hours, alone, and without the ability to claim for holiday or sick pay, means that every day lost is a day unpaid and without business. Planning ahead – for a holiday perhaps – is doable, and it’s the only way that sole traders can ever really get any proper time off.
- Less attractive to clients: Sole traders, unless they’ve somehow built up goodwill beforehand, don’t have the prestige that limited companies do. They are therefore at a disadvantage when it comes to creating a professional business image or trying to attract investment. The business plan that you have in place may be solid enough, but it may not be enough to convince others that you’re a risk worth investing in.