A sole trader, also known as a sole proprietor, is a self-employed individual who runs a business. This is the simplest form of business structure compared to other options, like being a limited company or a partnership. Understanding how being a sole trader can affect your self-employed business is crucial for maximising your business finances. This guide explains what it means to be a sole trader and covers its tax implications, pros, and cons.

Sole Trader Tax Rates

As a sole trader, you'll pay income tax on your business profits after deducting allowable expenses. The tax rate you'll pay depends on your income and falls into four main categories:

  1. Income £0 – £12,570: No tax payable
  2. Income £12,571 to £50,270: 20%
  3. Income £50,271 to £125,139: 40%
  4. Income £125,140 and above: 45%

If you have any additional taxable income besides your sole trader business, you must add this to your self-employed profits to calculate your total taxable income.

National Insurance Contributions for Sole Traders

In addition to income tax, sole traders are liable for Class 2 and Class 4 National Insurance Contributions (NICs) based on their profits. Class 2 NICs are payable if you earn over the small profits threshold, while Class 4 NICs apply if your profits exceed the lower profits limit.

Benefits of Being a Sole Trader

  1. Simpler registration process: Registering as a sole trader is relatively straightforward compared to setting up a limited company. You can register online or by post with HMRC.
  2. Privacy: As a sole trader, you're protected by HMRC's taxpayer privacy rules, which allow you to maintain control over what accounts and business information are available to the public. In contrast, limited companies must submit company accounts and director details to Companies House annually, which are then made public.
  3. Complete ownership: Being the sole owner means you have full control over decision-making without consulting other directors, which is common in companies with multiple directors.
  4. Flexibility to change: You can easily change your business structure from a sole trader to a partnership or limited company when you decide it's the best option.
  5. Less paperwork: Due to fewer regulations and obligations, sole traders have less administration and paperwork to deal with than limited companies.
  6. Lower setup costs and accountancy fees: With fewer obligations and regulations, sole traders generally pay less in accountancy fees compared to limited companies. Running a limited company may also require additional services like a solicitor and a company formation agent.

Disadvantages of Being a Sole Trader

  1. Unlimited liability: As a sole trader, you have unlimited liability for your business debts. Unlike a limited company, you may need to sell personal assets to repay business debts.
  2. Fewer tax efficiency options: Depending on their business income, sole traders may have fewer tax planning opportunities than limited companies.
  3. Public perception: Some organisations prefer working with limited companies over sole traders due to the added legal protection a limited company provides.
  4. Limited financing options: Lenders may prefer or only provide finance to limited companies because of the increased legal protection compared to sole traders.

Sole Trader Self-Assessment Tax Returns

After registering as a sole trader with HMRC, you'll receive a 10-digit Unique Taxpayer Reference (UTR) number and a self-assessment record. You must complete an annual self-assessment tax return, reporting your sole trader income, expenses, and any other income to HMRC.

HMRC will calculate your tax liability based on your self-assessment tax return and expect you to pay your tax bill by January 31st following the relevant tax year.

Making Tax Digital for Sole Traders

Making Tax Digital (MTD) is an initiative to digitise the tax system and will affect sole traders at different times depending on their income level. Under MTD for Income Tax Self-Assessment (ITSA), sole traders must keep digital records and report to HMRC quarterly instead of filing an annual tax return.

HMRC expects sole traders with an income of £50,000 or more to comply with MTD for ITSA from April 2026 and those above £30,000 to comply from April 2027. Sole traders with income below the £30,000 threshold will be required to submit under the MTD regime at some point after April 2027.

Registering as a Sole Trader

To register as a sole trader, you must set up a self-assessment record with HMRC, requiring you to report your sole trader income on a tax return each year.

First-time registration for self-assessment: If you're registering for self-assessment for the first time, HMRC prefers you set up a business tax account. You can open this account while registering for self-assessment, and it will become a useful tool for managing your business in the future. You'll need a Government Gateway user ID and password to sign in, which you can create if you don't already have one.

HMRC will post a 10-digit UTR number to you within about 10 working days, or you can access it through your HMRC app or personal tax account online. Keep your UTR number safe, as you'll need it when dealing with your self-assessment record.

If you've previously registered for self-assessment: If you already have a self-assessment record, you can inform HMRC about becoming a sole trader by completing the CWF1 form online. You'll need your 10-digit UTR number to complete the submission, which you can find in your tax account, HMRC app, or past self-assessment correspondence from HMRC.

Alternatively, you can complete the CWF1 form online, print it, and send it by post to the address provided on the form.

VAT Registration for Sole Traders

VAT registration for sole traders is optional and voluntary. However, sole traders are subject to the same VAT rules as any other business, and registration is mandatory if their taxable turnover meets the VAT threshold.

Sole traders can register for VAT even if their taxable income is below the threshold, allowing them to reclaim VAT on qualifying purchases. However, there are downsides, such as adding VAT to your prices and the extra administration involved in submitting VAT returns.

In specific circumstances, a business can be exempt from VAT. For example, when all the supplies your business buys are zero-rated for VAT, you can also be partially exempt from VAT if your business has incurred VAT on purchases related to exempt supplies.

The Role of a Sole Trader Accountant

Specialist personal tax accountants can help relieve the pressure of bookkeeping, producing accounts, submitting VAT returns, and filing your tax return with HMRC. They can also provide support in other areas, such as:

  1. Keeping you compliant with tax regulations
  2. Update you on changes like Making Tax Digital.
  3. Offering advice on tax planning and optimising your business finances

Being a sole trader is a simple and flexible way to run your self-employed business. However, it's essential to consider the potential drawbacks, such as unlimited liability and fewer tax efficiency options. By understanding the tax implications, registration process, and the role of an accountant, you can make informed decisions about your business structure and financial management.

"Did you know that under COP9, HMRC can check your income from the last 20 years if they think you didn't tell them about some of it? You could face big fines or even legal problems if you haven't reported some income. So, it's important to tell HMRC about all the income you make to avoid trouble. It's the right thing to do, and it helps you stay worry-free and financially safe. You can tell HMRC about your income using their Disclosure Services, and if you have income or gains from other countries, the World Wide Disclosure Facility is there to help."