If you’re ready to strike off on your own as self-employed, you may need to register as a sole trader for tax purposes. Here’s everything you need to know about setting up as a sole trader with HMRC.
What is a sole trader and who qualifies?
A sole trader is an individual who runs their own business and is considered self-employed. With sole traders, there’s no legal distinction between the business and its owner. By contrast, when you run your business as a limited company, it’s considered a separate entity for legal purposes. You can be a director and shareholder in the company, but it must be registered as its own entity with Companies House.
So, what does the lack of distinction between business and owner mean in practice? Sole traders are personally responsible for:
Keeping accurate records
Recording profits and losses
Paying business debts
If any of the following circumstances apply, you should set up as a sole trader:
You earned more than £1,000 from self-employment during the tax year.
You must prove that you’re self-employed for tax credits or benefits.
You wish to make voluntary Class 2 National Insurance contributions.
How to register as a sole trader
The main purpose of registering as a sole trader is to keep track of tax obligations and payments through Self Assessment returns. Sole traders are responsible for filling a tax return through the Self Assessment system each year.
You can register online using the HMRC website.
Another important aspect to consider when looking at how to register as a sole trader is choosing a business name. These don’t have to be registered, but you need to use the business name on any official paperwork, including invoices.
Here are a few of the HMRC requirements for sole trader business names:
You can use your own personal name
You cannot use any offensive words
You cannot include ‘limited’ in any form including ‘limited liability partnership’ or ‘Ltd’
You cannot use any existing trademarks
Sole trader responsibilities
Setting up as a sole trader is quite straightforward, particularly when compared to registering as a limited company, but there are a few responsibilities to consider. For example, sole trader accounts must include detailed records of business sales and any associated expenses.
You’re also required to submit a Self Assessment tax return each year, paying Income Tax on profits. Class 2 and Class 4 National Insurance contributions also apply to sole traders, so you must apply for a National Insurance number if you’ve just arrived in the UK.
Some sole traders will also need to register for VAT. The threshold is an annual turnover of £85,000, at which point you must be VAT-registered.
Sole trader advantages and disadvantages
Many freelancers or individual small business owners start off as sole traders because it’s quite simple to get set up with HMRC. All you need to do is register for Self Assessment, pick a business name, and you’re official.
There are a few additional sole trader advantages:
There’s less admin involved.
When setting up as a limited company, you must deal with annual accounts, corporation tax, and filing paperwork with Companies House. Sole trader accounts must include records of income and expenses, but there’s no need to worry about shareholders or the bureaucracy involved with IR35 rules.
There are fewer costs to consider.
When forming a limited company, you may need to employ an accountant, company formation agent, and solicitor to sort out the admin mentioned above. It’s free to set up as a sole trader without these types of professional fees. There’s also no need to pay the registration fee at Companies House.
You’ll have greater privacy.
When you register as a limited company, all details about company directors and accounts are revealed on the Companies House website. However, as a sole trader you’re protected by taxpayer confidentiality regulations at HMRC.
On the other hand, registering as a sole trader isn’t right for everyone. There are a few potential disadvantages to consider, the first of which is that unlimited liability can be a problem if your business goes under. If your business incurs losses, it’s your own personal assets on the line because there is no distinction between you and your business. It can also be more tax efficient to register as a limited company, particularly once your earnings rise above a certain threshold. Yet for small-scale contractors and solo freelancers, registering as a sole trader is usually the best bet.
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