A sole trader is personally liable for the debts of the business, which means that their home and other personal assets may be at risk if they are unable to pay the business’s debts as they fall due.
Many people who start their own business do so as a sole trader, often referred to as a sole proprietor or sole operator.
Below explains the advantages and disadvantages of this type of business status. It outlines the tax requirements for sole traders, covering registering for self-assessment, record keeping, and liabilities for income tax and National Insurance. It also outlines the requirements regarding business names for sole traders.
Advantages of operating as a sole trader
- Sole traders have sole control of their business, allowing them to make business decisions quickly and easily.
- All profits, after tax, belong to the business owner.
- It is relatively straightforward to start up or cease trading as a sole trader.
- Generally, overhead costs are easy to keep under control because sole traders typically start up on a small scale, often trading from a home base.
- Sole traders don’t need to have their business accounts audited or made public, which saves time and money.
- Some people find it personally satisfying to work for themselves. Sole traders can put all their enthusiasm into the business and make the most of their own ideas.
Disadvantages of operating as a sole trader
- Sole traders are personally responsible for all debts and liabilities that their business incurs. This means that both their business and personal possessions could be at risk if the venture runs into trouble.
- They may have to work very long or unpredictable hours.
- Sole traders who suffer an injury or illness may not receive an income during the time they cannot work.
- Sole traders often experience greater difficulty raising money for their business than limited companies. For example, it can be harder for sole traders to secure bank loans and they cannot sell a share or shares to raise funds to invest in the business.
- Sole traders generally start up using their own savings, loans secured against personal assets, or with money borrowed from friends and family.
- Business growth may be restricted by a sole trader’s limited knowledge or skills.
What are the tax requirements for sole traders?
Sole traders must register for self-assessment as a self-employed person with HMRC. They must complete an annual self-assessment tax return and pay income tax and Class 2 (and in some cases also Class 4) National Insurance Contributions (NICs). If it appears that their turnover will be more than the mandatory VAT registration threshold in any 12-month period, they must also register for VAT. The VAT registration threshold is announced in the Chancellor’s Budget and usually changes every April. They must also keep records of their business income and expenditure, and their personal income.
Registering for self-assessment as self employed
Sole traders need to register with HMRC for self-assessment when they start trading. At the latest, they must register by 5th October after the end of the tax year for which a tax return is needed (that is, the tax year during which they started to trade).
All profits made by a sole trader are potentially taxable, including money that has been taken out for personal use in the form of ‘drawings’ and any money that remains (for example as cash in the bank) at the end of the tax year.
However, tax is only charged on ‘taxable’ profits, which is the amount of profit that remains after deduction of allowable business expenses, and capital allowances on equipment. In addition, sole traders are entitled to the same tax-free personal allowances in relation to income tax as people who are paid under PAYE (Pay As You Earn), and so for the tax year 2015/16 the first £10,600 of a sole trader’s taxable profit is free of tax.
Once the tax due on the taxable profits has been calculated and paid, sole traders retain the remainder of the profits, which they can choose to draw out (as personal income) or re-invest for business purposes.
Sole traders must complete a self-assessment tax return each year, giving details of all sources of income, tax allowances, relief or gains. They can file self-assessment tax returns online or by post. Under self-assessment, income tax payments are due twice a year in January and July. However, sole traders can choose to make regular weekly or monthly payments in advance.
National Insurance contributions (NICs)
Sole traders must pay Class 2 NICs if the following circumstances apply:
- They are over 16 years of age, but under the state retirement age.
- Their profits exceed the small profits threshold (£5,965 for 2015/16).
Class 2 NICs count towards an individual’s state pension. For this reason, sole traders may choose to pay Class 2 NICs even if their profits fall below the small profits threshold.
Sole traders with profits above the lower profits limit (£8,060 for 2015/16) must also pay Class 4 NICs, which are charged at a percentage of a sole trader’s profits, based on the information provided in their self-assessment tax return.
Business owners whose turnover is above the mandatory VAT registration threshold in any 12-month period must register for VAT. Sole traders whose turnover is below the VAT threshold may choose to register voluntarily.
Sole traders need accurate financial records to help them complete their tax returns. They also have a legal obligation to keep these records for a specified time, in case HMRC asks to inspect them.
Sole traders must keep:
- Records of all business income and expenses, and personal income. (These must be kept for at least five years after the 31st January submission deadline for the tax year they relate to.)
- All VAT records, if the business is registered for VAT. (These must be kept for at least 6 years.)
- Any PAYE records, if the business employs staff. (These must be kept for at least 3 years after the end of the tax year they relate to.)
Go to www.gov.uk/self-employed-records/what-records-to-keep for more information about keeping records.
Sole traders can trade under their own name or choose a different name for their business. If a sole trader chooses to trade under a name that does not include their surname, they must ensure their business stationery displays both their name and the trading name of the business – for example, Peter Simpson, trading as Quicksilver Plumbing.