If you’re starting a small business in the UK, one question you may be wrestling with is whether to register as a sole trader or as a limited company.
This is actually the first big decision most entrepreneurs face, and it’s an important one, as choosing the right legal structure for your new start-up can affect a wide range of things, from protecting your assets to how tax-efficient your business is.
Of course, there are pros and cons to any kind of business structure, so deciding which is best for you really comes down to your own unique circumstances, as well as your general preferences.
In this article, we’ll break down how being a sole trader works, explaining the key differences from being a limited company, and then walk you through the registration process.
What is a sole trader?
A sole trader is an individual who owns and runs their own business.
As a sole trader, there’s no legal distinction between you and your business, and so you’re personally liable for everything that happens, in both a financial and a legal sense.
This includes things like the business’s finances, taxes, and any debts it takes on.
How does being a sole trader work?
Well, because there’s no legal separation between a sole trader’s personal finances and those of the business, you’ll pay Income Tax on your profits, whether or not you actually use them personally.
This means that, even if you leave them in the business, you’ll pay personal tax on them.
Who can become a sole trader?
Technically anyone can if they set up their own business, but – depending on how much you earn from sole trader income – you might need to register for Self Assessment in order to pay the correct amount of tax.
Sole traders are allowed to earn up to £1,000 from self-employment (known as the trading allowance) in a tax year before they need to register for Self Assessment and start sending tax returns to HMRC.
When do I need to register as a sole trader?
You should register for Self Assessment no later than the 5th October in your second tax year of business.
The tax year runs from 6th April to 5th April.
Failure to notify HMRC that you need to register for Self Assessment as a sole trader can result in a penalty, even if it was a genuine oversight on your part.
These penalties are in addition to any tax which might be overdue.
Why register as a sole trader?
As far as HMRC is concerned, sole traders and their businesses are one and the same.
This might mean there’s more risk for you personally due to the increased liability, but it also means you get to keep all of the profits.
Other benefits include being able to operate your business with relative privacy, as there’s no requirement for a sole trader to make information available to the public.
What’s more, there’s a limited amount of admin when it’s just you, and this saves you time in the long run.
What are your responsibilities as a sole trader?
Your responsibilities as a sole trader depend on how you need to report your income tax.
Paying tax
If you don’t qualify for MTD for Income Tax (MTD IT) yet, you’ll complete a Self Assessment tax return to HMRC each year and pay Income Tax and National Insurance on your earnings.
If your qualifying earnings mean you do need to report your earnings via Making Tax Digital for Income Tax, you’ll submit four quarterly updates, followed by one final declaration, which replaces the Self Assessment.
Keeping records
Either way, you’ll also need to keep detailed and accurate bookkeeping records, and if you are operating under MTD IT, you’ll need to use MTD compatible software.
Sole trader vs limited company: what’s the difference?
As a sole trader, there’s no legal distinction between you and your business – meaning you’re personally liable for everything that happens within it.
If something unforeseen occurs, for example, a client sues you for professional negligence and wins a financial settlement, you could end up losing personal assets to cover the cost.
A limited company works differently. As the name suggests, your personal liability is limited – any debts belong to the company, not to you as an individual.
This generally makes it a more protected structure for directors and shareholders, since business debts stay separate from personal finances.
You’re more likely to align with a sole trader business structure if:
- Your profit figure is below £30,000
- Your business is relatively low-risk in terms of potential liability
- You only have one source of income
If you’re a higher earner, or you work in a high-risk industry, it may be best to opt for a limited company – but speak with an accountant first.
How to register as a sole trader?
Sole traders register by signing up for Self Assessment with HMRC.
You can register for Self Assessment using your online Government Gateway account, or via your GOV.UK One Login – depending on which one you have.
Alternatively, if you have been registered for Self Assessment in the past, you can reactivate your registration using a CWF1 form rather than having to create a brand new account (as this can cause confusion).
Find more help in our online accounting hub, and learn more about how to find the right accountant for your business.
