Sole trader vs self employed explained

Sole trader vs self employed

Working for yourself can be an appealing prospect as it provides you the opportunity to be in control of your own working life and personal finances. If you are considering working for yourself you will need to consider whether you want to be self-employed or a sole trader. In this article, we explain what being a sole trader or self-employed means as well as explaining the key differences and the accounting and tax obligations.

To be a self employed sole trader, you must be the sole owner of a business. If you have a business partner or partners, you are still classed as self-employed but you will most likely be either a ‘limited company’ or a ‘partnership’.

Defining the differences between a sole trader and self-employed can be difficult to understand. For instance, a sole trader is always self-employed but not all self-employed people are sole traders.

What does it mean to be a sole trader?

A sole trader is an individual that owns their own business with no other partners or directors. They are the sole owner of their business. As a sole trader business, all debts the business may accrue also belong to the individual, along with any profits and associated taxes. This is due to there being no legal distinction between the business and the individual.

What does it mean to be self-employed?

Being self-employed is a general term that is used to describe all individuals that work for themselves, whether it be as the sole or joint owner(s) of a business.

What are the key differences?

The term “sole trader” refers to a specific type of business structure, indicating that the business is owned and operated by one individual. This structure is different from employment status, which can be categorised as self-employed or employed by another company.

The key distinctions include:

Sole trader: This is a business structure where one person is responsible for the business, including all its profits, debts, and liabilities and paying tax. Sole traders run their businesses independently but can employ others if needed. They must file and pay tax themselves and are not part of the PAYE system used by employees.

Self employed: This term describes a self employed person, someone who operates their own business or works on a freelance basis, meaning they are not employed by another company. Self-employed individuals manage their own tax affairs, usually submitting annual tax returns to pay tax directly to the government. This status includes both sole traders and owners of limited companies.

Limited company owner: If a self-employed individual chooses to operate through a limited company, the business is a separate legal entity from the owner. This structure provides limited liability protection, meaning the owner’s personal assets are not at risk if the company faces financial difficulties. The owner may pay themselves through a combination of salary and dividends and they must comply with corporate tax requirements.

Accounting and tax obligations of being a sole trader

If you are a sole trader you have the following accounting and tax obligations.

·         Register for self-assessment tax returns and calculate your tax obligations.

·         Pay income tax and National Insurance contributions at the appropriate rate.

·         Register and pay VAT, if your earnings exceed the VAT threshold.

·         Keep detailed records of your business sales and expenses.

Accounting and tax obligations of being self-employed

Self-employed individuals have the same accounting and tax responsibilities as sole traders (listed above).

However, depending on the type of self-employed business they may be subject to additional accounting and tax obligations. For example, a limited company would be required to pay corporation tax which is a liability of the company. An individual is then liable to pay tax on their personal income, being dividends or payroll income received from the company, or profit shares received from a partnership.

Sole trader responsibilities

Although a single trader is the most effective approach to getting your company off the ground, it requires some administrative tasks. If you decide to start a sole trading business, you will need to register as a sole trader with HMRC. Unlike limited companies, however, there is no requirement for sole trader businesses to be registered at Companies House. Because you are self-employed, you must file an annual Self-Assessment tax return by 31st January each year in respect to the previous tax year. Your Self-Assessment tax return includes your income tax and National insurance contributions.

Sole trader or limited company

If you are setting up a business on your own you can decide to become a sole trader or setup a limited company. There are distinct differences between the two and scenarios where one is better than the other and vice versa.

Here are some of the key differences between being a sole trader and a limited company:

• Being a sole trader is much easier as there is less admin which can save you time and money.

• In most scenarios, being a limited company is more tax efficient. However, if business profits are low being a sole trader can be more tax efficient, depending on the scenario.

• It is easier to pass on a limited company through sale or inheritance.

Our small business accountants

If you are deciding on whether to setup as a sole trader or limited company, it is recommended that you seek professional advice. We have a proven track record in helping new and small businesses get off the ground and continuing to grow. Our small business accountants can help in all aspects of setting up and running your own small business here.

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