The essential guide to becoming a sole trader

Many dream of being their own boss, but setting up a business can require a lot of thought, research and preparation.

One of the most popular ways to start a business is to become a sole trader.

As of 2023, there were 3.1 million registered sole traders working in the UK.

But what exactly is a sole trader business, and is it the right way for you to get started in working for yourself?

This guide will look at some of the steps required to help you on the way to running your own business.

What is a sole trader?

A sole trader is a self-employed person who owns and runs their own business as an individual.

This is different from owning a limited company or being in a partnership.

You can be a sole trader as your only job or work as a sole trader while working for an employer.

Setting up as a sole trader is the fastest and easiest way to become your own boss.

With little in the way of paperwork and complete control over how you work, you can get your new business up and running immediately.

You can then scale your operations, adjust your working hours, and change your business model.

What are the benefits of being a sole trader?

Sole traders, as the owners of their company, are liable for their business’s successes and failures.

While that may sound daunting, being a sole trader has many benefits.

For instance, you’ll be able to take home 100% of the profit your business makes after tax.

It can also be a great way to test out a business idea or grow your start-up until it generates enough income to support you.

Here are some of the key benefits:

• control – as a sole trader, you have complete control over your business decisions
• simplicity – setting up and running a sole trader business requires less paperwork than more complex business structures
• privacy – businesses operated by sole traders don’t need to disclose their accounts publicly
• tax efficiency – sole traders might have access to certain tax reliefs and allowances
• flexibility – sole traders can set their working hours and make changes to business operations quickly and easily
• profit retention– profits from all your hard work go directly into your pocket.
   

What are the disadvantages of being a sole trader?

There are several drawbacks to being a sole trader compared to setting up as a limited company.

These include:

• unlimited liability – sole traders are personally liable for business debts, which could pose significant financial risks
• funding challenges – sole traders may find it harder to raise funds as lenders may view you as ‘risky’
• sole responsibility – if you become unable to work, the business could suffer or stop operating
• client perception – potential clients might perceive a sole trader business as less professional than a limited company
• fewer tax planning opportunities – all the profit you make in a year is subject to income tax
• selling your business– transferring a sole trader business can be tricky, as the business is typically closely tied to the individual owner.

While being a sole trader may come with a lot of responsibility, there are a number of income protection and business insurance policies available to ease the financial risk of a legal claim, negligence claim, or illness to either yourself or a key member of staff.

Sole trader vs limited company – what are the main differences?

Registering as a sole trader is more straightforward than setting up a limited company.

However, as a sole trader you’re liable for any debts that your business incurs, which means your savings, home, and other possessions are at risk from creditors.

If the nature of your start-up means you’re likely to build up substantial debts, then you may want to consider setting up a limited company instead.

A limited company operates as a separate entity and is not connected to your personal finances.

This reduces the financial risk to you if your business were to be unsuccessful.

Often, private limited companies have a board of directors or shareholders – although these shares cannot be sold on the public stock market.

However, a limited company could involve more administrative responsibilities.

As a director of a limited company, you would have a legal responsibility to keep accurate records, report changes, and ensure your accounts are audited, if necessary – failure to do so could result in penalties.

The process of setting up a limited company is different from setting up as a sole trader.

You’ll need to register your company name, address, and various other details with Companies House and notify HM Revenue & Customs (HMRC) when your business begins trading.

Read our guide on private limited companies.

Can I be a sole trader and be employed?

Being a sole trader means flexibility – you can work full or part-time, or even on a casual basis while still being an employee (subject to the terms of your employment contract).

However, keep in mind that there are tax implications if you are both a sole trader and employed by someone else.

As an employee, your taxes are typically deducted from your salary through PAYE, but as a sole trader, you must complete a self-assessment tax return for HMRC, covering your business income and expenses.

You may want to seek professional tax advice to manage both effectively.

How much does it cost to set up as a sole trader?

It costs nothing to set up as a sole trader if you register your business via HMRC.

You may have some initial costs depending on the type of business you are trying to set up.

These could include purchasing necessary equipment or insurance, securing a workspace, buying stock, creating a website, marketing, or hiring an accountant.

These costs can vary widely depending on the nature and scale of your business.

You could consider taking out a sole trader business loan – Start Up Loans provides up to £25,000 in loan funding for new businesses.

How do I pay tax when setting up as a sole trader?

As a sole trader, you’ll need to pay income tax based on your business profits, along with National Insurance contributions (NICs).

This is done through a process called self-assessment, which involves submitting a form each year to HMRC to calculate the amount of income tax you owe and then paying the required amount.

Once registered as self-employed, you’ll get a letter, usually in April, telling you when you need to complete your first self-assessment form.

You can check your National Insurance contributions by asking for a National Insurance statement online.

Do I need to register for VAT as a sole trader?

You don’t need to worry about VAT until your business turnover exceeds the current VAT threshold (£90,000 as of June 2024) over a 12-month period – although you can choose to register for VAT at any time.

Once registered for VAT, you must charge VAT to all your customers.

You can then claim back the VAT you’ve paid on business purchases.

Can I employ people as a sole trader?

Being a sole trader doesn’t mean you have to work alone.

Hiring staff can create additional responsibilities, including providing a safe work environment, auto-enrolling eligible employees in a workplace pension scheme, and ensuring your business has employers’ liability insurance.

When you employ staff, you must notify HMRC and collect income tax and National Insurance contributions from your employees’ monthly salaries.

You will also need a Pay As You Earn (PAYE) payroll scheme.

You must provide your employees with an employment contract within their first two months and adhere to employment laws concerning holiday entitlement, sick pay, maternity/paternity rights, and more.

Fostering a positive work culture and investing in training and development opportunities could help retain and motivate staff, as well as attract new talent.

Managing a team can be challenging but can also drive your business growth and allow you to share your vision and success with others.

Read our guide to new employer responsibilities.

How to register as a sole trader

Setting up as a sole trader can be a straightforward process.

1. Name your business

You can trade under your own name or select a specific business name.

Be aware that if you opt for a business name, your business stationery must show both your own name and the business’s trading name.

Don’t pick a name that’s the same or too similar to that of an existing company – you could end up in a legal dispute.

Research online for businesses with similar names in your local area and check the register at Companies House to see if a limited company with that name already exists.

Other rules apply when naming your business.

Be careful not to include offensive words or sensitive words such as Royal or British, which may mislead your customers.

Read our guide on how to choose a name for your new business.

2. Registering with HMRC

Setting up as a sole trader is straightforward.

You need to register with HMRC within three months of becoming self-employed, even if it’s on a part-time basis.

Failing to do this will mean paying a £100 penalty.

You can register by registering with HMRC online.

Alternatively, you can download and complete HMRC’s CWF1 form and post it to the address on the form.

You’ll need to provide HMRC with your name, date of birth, address, telephone number, National Insurance number, the name and type of your business, and its start date.

3. Sign up for financial self-assessment

You or your accountant must complete a self-assessment form each year for HMRC detailing your income and business expenses for the last tax year.

As a sole trader running a small business, you can use a cash accounting method, which means you’ll only have to pay tax on the money that actually comes into and out of your business during the tax year.

You can deduct business expenses such as the cost of vehicles, computers, and stationery, as well as day-to-day running costs like electricity to reduce the amount of income tax payable.

Any money owed for the tax year ending in April must be paid by 31st January of the following year.

HMRC may ask you to make a payment on account for the current tax year, in which case you’ll need to do this by 31st July.

You can complete a paper self-assessment form to be submitted by 31st October or online by 31st January of the following year.

With its later deadline, filling in the online form may be the best option with the benefit that you’ll see instantly how much you’ll have to pay.

An online account for your self-assessment is set up automatically when you register as self-employed.

You’ll be sent a Unique Tax Reference (UTR) number, which you’ll need to complete your self-assessment and for all correspondence with HMRC.

As a sole trader, you must pay Class 2 National Insurance contributions (NICs).

This is collected at the same time as your tax payment via self-assessment.

You may need to pay Class 4 NICs if your annual profits exceed £8,060, but this will be calculated automatically when you complete your annual self-assessment form.

Do I need a business bank account?

You do not need a business bank account as a sole trader.

You can use your personal bank account for all business transactions.

This is because, as a sole trader, your personal and business income is treated as the same by HMRC for tax purposes.

However, many sole traders prefer to set up a business bank account as this makes it easier to track their business finances.

Do I need a licence or permit to be a sole trader?

Depending on the industry, you may also need to pay for specific licences or permits to operate your business.

For example, if you are running a food business, you will need a food business registration, or if you are serving alcohol, you will need an alcohol licence.

Always check with your local council or relevant professional bodies to determine which licences or permits you’ll need for your start-up.

What about sole trader insurance policies?

Once you hire staff, you are legally required to take out employers’ liability insurance to protect your employees if they fall ill or are injured while on the job.

You could be fined up to £2,500 per day if you don’t.

Other forms of business insurance aren’t legal requirements but offer protection should your business or products harm others.

For example, it’s a good idea to have public liability insurance if members of the public come to your premises or could be injured as a result of your business.

Some professions may require policies such as professional indemnity insurance, which is designed to protect your business against the cost of settling or defending a customer’s claim that your work was inadequate or caused them to lose money.

What business records should I keep?

It’s important you stay on top of your business paperwork to be a successful sole trader.

Consider keeping both a digital and paper record of every business transaction, including invoices issued to customers, receipts for payments made, payments into and out of your bank account, receipts for business expenses, and PAYE records if you employ staff.

If you use traditional accounting methods, you’ll also need records of money you’re owed but haven’t received yet and money you’re committed to spending but haven’t paid yet.

It may be easier to gather and store paperwork as you go rather than try to piece everything together later when you or your accountant are filling in your annual self-assessment.

If paperwork is missing, inform HMRC that you’re using estimated rather than actual figures.

Keep your paperwork for at least five years after the 31st January submission deadline of the relevant tax year, as HMRC may also ask to see them to check you’re paying the right amount of tax.

“Should I get an accountant when I start my own business?” is a question we’re regularly asked here at Start Up Loans.

There is no right or wrong answer; it’s simply a matter of preference.

What business expenses can I claim as a sole trader?

As a sole trader, you can deduct certain business expenses from your income, reducing your taxable profit and the amount of tax you pay.

Any expenses you claim should be wholly and exclusively used to run and grow your business.

These can include:

• office costs –such as stationery, business mobile phones, and computer software. You can claim a proportion of your heating, electricity, council tax, mortgage interest or rent, internet, and telephone use if you work from home
• travel expenses – costs of business-related travel like fuel, parking, train or bus fares, hotel rooms, and meals on overnight business trips can be claimed
• professional fees – costs for professional services, such as hiring an accountant or legal advice for business matters, are deductible
• clothing expenses – uniforms, protective clothing needed for your work, and the cost of laundering those items
• marketing costs – money spent on advertising, website costs, business cards or printing brochures can be deducted
• equipment and tools – essential items to run your business, such as machinery, computers or furniture, may be classified as allowable expenses.

Find out more about the expenses you can claim as a self-employed sole trader on the government website.

How to close a sole trader business

Before closing the doors on your sole trader business, you will need to take several steps first.

First, you must inform HMRC that you’ve stopped self-employment, which can be done online or by post.

Next, you must complete a self-assessment tax return by the deadline to cover your business trading up to the date you stopped being self-employed.

You will also need to pay all your outstanding tax and National Insurance contributions for the period up to the end of your trading.

Finally, cancel your VAT registration if applicable and inform other people or organisations related to your business, like clients or suppliers, about the closure.

What are the alternatives to being a sole trader?

Being a sole trader isn’t for everyone. 

There are other business structures you can use for your start-up, including:

Limited company

This separates your personal assets from your business assets, offering protection if your business runs into financial trouble.

Although the administrative requirements are more complex than being a sole trader, it could be more tax efficient, particularly for higher earners.

Limited liability partnership (LLP)

As with a limited company, this structure protects your personal assets from business debts.

However, it also operates much like a traditional partnership, providing the flexibility to divide profits among partners as you see fit.

Partnership

With this structure, you run a business with one or more partners, sharing the profits and risks.

Partnerships can be easy to establish, but each partner is personally liable for business debts.

Cooperatives

The business is owned and run by members who share the profits.

This democratic approach can lead to a more balanced and fair business operation.

Your choice of business structure could depend on your circumstances, business goals and personal preferences.

However, before taking a step forward, it could be a good idea to carefully consider each option and seek professional advice.

Planning to become a sole trader? How can Start Up Loans help?

Start Up Loans is a government-backed scheme helping budding business owners all over the UK, including sole traders looking to start their own business.

We provide personal loans for business purposes to help your start-up get off the ground, ranging from as little as £500 to £25,000.

Depending on your eligibility, you could access a loan of up to £25,000 with a 6% fixed rate interest rate per annum.