What is a sole trader?
In the simplest terms, a sole trader is someone who is self-employed and owns and operates their own private business.
They are solely responsible for all aspects of the business, including decision-making, profits, losses, and legal obligations, including paying tax. It’s the simplest form of business ownership available.
The basic responsibilities include:
- Keeping accurate business records and records of expenses.
- Completing and sending a Self Assessment tax return every year.
- Paying Income Tax on your profits.
- Paying Class 2 and Class 4 National Insurance.
Registering as a sole trader is easy. Your main obligations are keeping records and submitting profit and loss to HMRC yearly.
So, what are the advantages and disadvantages of being a sole trader?
Advantages of being a sole trader
- Easy setup and low costs: Setting up as a sole trader is relatively simple and inexpensive compared to forming a limited company. There’s less paperwork involved, and you only need to register with HM Revenue and Customs (HMRC) as self-employed.
- Full control and flexibility: As a sole trader, you have complete control over your business decisions and can adapt quickly. This is excellent if you have more than one self-employed venture going.
- Simplified accounting and tax: Sole traders typically have less complex accounting and tax requirements than limited companies. Profits are taxed as personal income, which can simplify the process of filing annual self-assessment tax returns. You only pay tax on your profits, and you’ll also be able to claim allowable expenses against your tax bill.
- Privacy: Unlike limited companies, sole traders are not required to disclose financial information on public records. Conversely, data from companies registered with Companies House is publicly available.
Disadvantages of being a sole trader
- Unlimited liability: Sole traders are personally liable for any debts or losses incurred by their business.
- Difficulty raising capital: Sole traders may find it harder to access funding or secure loans, as banks and investors may perceive them as higher risk than limited companies.
- Potential tax inefficiencies: While accounting and tax are generally simpler for sole traders, limited companies can sometimes offer more tax-efficient options, such as lower corporation tax rates and dividend payments.
- Limited growth potential: If you expand to add business partners and employees to your business, you’re more limited as a sole trader. However, it is still possible to employ people as a sole trader.
Is it worth switching from a sole trader to a company?
Switching your business structure from a sole trader to a limited company may lead to tax savings.
For example, while sole traders pay Income Tax on their profits and Class 2 and Class 4 National Insurance contributions, limited companies are subject to Corporation Tax.
Corporation Tax is currently 19% compared to 20 – 45% for self-employed. However, if you wish to take money out of your business to pay yourself, directors still pay tax on dividends of 8.75 – 33.75% and personal income tax of 20 – 45% on income paid via payroll.
Additionally, limited companies typically don’t need to make Income Tax payments on account, while sole traders do. While this does not directly result in tax savings, the timing of such payments may cause cash flow issues.
The tax savings of swapping to a limited company are not as clear-cut as they once were.
Before making any big decisions, speaking to an accountant about your business and personal situation is essential.
To learn how Hugh Davies can help you navigate your finances and manage your tax responsibilities as a sole trader, simply get in touch with our team today.