What is a sole trader and how to become one
Key Takeaways
A sole trader is an individual who owns and operates their own business
Sole traders enjoy full control of their business, but also face personal liability for business debts
Insurance options for sole traders include public liability insurance, professional indemnity insurance, and health insurance
What is a sole trader?
A sole trader (also known as a sole proprietor) is an individual who owns and operates their small business alone. It’s a great option for freelancers, and other self-employed individuals such as plumbers, photographers, or personal trainers who work independently, and enjoy being their own boss. The sole trader model is noted for its simplicity, control, and the full responsibility it places on the owner.
The sole trader model is quite different to other business structures like limited companies or partnerships. Limited companies provide limited liability, which generally protects personal assets in the event of business failure. Partnerships, on the other hand, involve sharing control and profits, contrasting with the sole trader's independent setup. Each structure offers its own advantages and challenges, making the choice dependent on personal circumstances and business goals.
Read also: what's the difference between sole traders and limited companies?
What are the benefits of being a sole trader?
Being a sole trader comes with its own distinct advantages, such as:
Ease of setup and minimal regulatory requirements
Relatively simple tax requirements — sole traders pay income tax and National Insurance contributions at the end of the tax year by completing a self-assessment tax return
Complete control over all business decisions and the direction of the business
A level of privacy not available to limited companies, who have to publish their accounts online via Companies House
What are the disadvantages of being a sole trader?
Being a sole trader also comes with some downsides:
Unlimited liability for your business finances, meaning that if your business gets into debt, you’ll be responsible for paying it off, and your funds, personal assets, or even house could be at risk.
Difficulty growing or attracting investment, because banks and investors may view sole traders as less reliable or attractive than a limited company or partnership.
How to become a sole trader
To ensure you meet legal and financial requirements to become a sole trader you need to:
Initially, you must inform HMRC that you are self-employed. This registration ensures you are included in the system for self-assessment tax returns. The process can be completed online, directly through the HMRC website. They provide a step-by-step guide.
As a sole trader, managing your taxes is paramount. You need to keep accurate records of your income and expenses. These records determine your tax liability. It’s advisable to familiarise yourself with the types of expenses that can be deducted. This can reduce your tax bill. Consider consulting a tax advisor if you find this aspect daunting.
To maintain an organised financial track, setting up a dedicated business bank account is recommended. This helps separate personal and business transactions. It simplifies accounting processes and tax preparation. You’ll also need to maintain comprehensive records of all business transactions, invoices, and receipts. Using accounting software can streamline this process and help you keep on top of your finances.
Register with HM Revenue and Customs (HMRC)
Manage tax responsibilities
Set up accounts business operations
What insurance do I need as a sole trader?
As a sole trader, it's crucial to secure the right insurance to protect your business from financial and legal issues. Your business insurance needs will depend on your business type and operation scale. Consulting with an insurance broker can provide tailored advice to meet your specific needs.
Below is a breakdown of the essential business insurance types you might need:
This insurance covers injuries or property damage caused by your business activities. It's especially important if your business involves direct client or public interaction.
Learn more about public liability insurance.
This insurance is important if you provide advice or services. It protects against claims of negligence or harm resulting from your professional advice or services.
Explore options for professional indemnity insurance.
Often overlooked, health insurance is critical for sole traders. It covers medical treatments and is vital for maintaining your health and business operations.
Consider options for self-employed health insurance.
Public liability insurance
Professional indemnity insurance
Health insurance
Alternatives to being a sole trader
Registering as a sole trader isn’t the only option. Other business types might better suit your needs. Two popular alternatives to being a sole trader are:
Limited company: A separate legal entity from its owner. It provides financial protection through 'limited liability'. Essentially, personal assets are safe if the business incurs debt or legal issues.
Partnership: Involves two or more people. They join forces to manage a business, sharing responsibilities, profits, and losses.
Benefits of each alternative structure
Limited companies often benefit from a professional image and credibility. This can be advantageous in attracting business and investment. They also enjoy potential tax efficiencies not typically available to sole traders. Partnerships offer simplicity in setup and flexibility in management. Partners pool resources and expertise to strengthen the business.
Factors to consider when choosing a business structure
Deciding on the right structure involves weighing several factors. Consider the level of personal financial risk you're willing to take; think about the administrative burden you can manage; and consider how you plan to scale your business. Each structure has its own implications for tax, liability, and control. These must be carefully considered to align with your business goals and personal circumstances.
How do I get sole trader business insurance?
You can compare business insurance for sole traders using MoneySuperMarket’s comparison tool. Think carefully about your business needs and make sure that you find an insurance plan that covers everything you need.
Frequently asked questions
A sole trader is any self-employed individual who runs their own business with no legal separation between the business and the individual. Essentially, if you work for yourself, are classed as self-employed, and make all your own business decisions, you are a likely classed as a sole trader.
Both the sole trader and limited company model have their own pros and cons, and there’s no right answer to which is better. Sole traders have more control over the business, simpler accounting, and more privacy, whereas limited companies have lower liability and possible tax advantages. You can find out more about the difference between sole traders and limited companies here.
A sole trader must complete a self-assessment tax return in order to pay income tax and National Insurance contributions. Tax rates will depend on business turnover. If business profits exceed a certain level (currently £90,000 per year), they’ll also need to be VAT registered and pay VAT accordingly.
As a sole trader, you’ll have the same personal allowance as an employed individual. This means that you won’t pay tax on the first £12,570 that you earn.
The sole trader tax model differs from the limited company model, which requires you to pay both corporation tax and income tax on a PAYE basis.
Registering as a sole trader is free. Although there may be other expenses to take into account such as accounting software, business insurance, and equipment, an advantage of being a sole trader is that the set up costs are relatively low, and there may even be no upfront costs to becoming one.
Sole traders are not legally required to set up a business bank account, however many choose to have one. It can be helpful to separate your business and personal finances, and having a bank account with your business name on it may help to boost professionalism, establish business credit, and link to specialised tools and services.
You can compare business bank accounts to find one that suits you.
If you’re a sole trader, you can offset your business expenses against your income on your self-assessment tax return. This means that you’ll only be taxed on your profit (your turnover minus your expenses). This is particularly helpful if you’re a new business owner, and can offset the high costs of starting up your business against your first year tax return.
