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What is the definition of a sole trader and being self-employed

How does it feel to be a sole trader? What is the difference between a sole trader and someone who is self-employed?

As a self-employed person, you work for yourself rather than for an employer. In a sole-trader relationship, the owner is the only person employed by the business.

As soon as you become self-employed, you need to notify HMRC so they can make sure you are paying Class 2 NICs and that you fill out a self-assessment form.

Directorships do not count as self-employment. Directors usually are employees of their companies and will receive the same salary as regular employees.

A sole trader versus a limited company

Sole traders avoid the hassle of registering with Companies House and presenting annual accounts, but one downside is that their personal assets are not separate from their business assets. Should the worst happen, you might lose your home and possessions to your creditors.

In addition, if you earn over £100,000 as a sole trader, you are advised to set up a limited company; once you pass the £100,000 threshold, your allowance begins to reduce, and for earnings after £125,140, it is nil. As of 2021, the corporation tax is 19 percent, compared with the current corporate tax rate of 15 percent.

Figure 1: Personal Allowance vs Earnings for Sole Proprietors

by Income Bracket PA
£0 – £100,000 £12,750
£100,001 – £125,140 Decreases by £1 for every £2 of income over £100,000
Over £125,140 £0

 

As of 2020/21

The tax consequences of registering as a limited company with a profit margin of around £30,000 are actually better according to CheapAccounting.co.uk.

Registering as a sole trader is much less expensive.

A sole trader is the easiest way to run a business because there are no registration fees to pay, but you do have to register as self-employed.

Records and accounts are straightforward, and you get to keep the profits.

This option comes with the disadvantage that you are personally responsible for any debt your business may incur, making it a risky option for companies that require significant investment.

A sole proprietorship is easy to establish. In the first three months after starting your business, you have to register specifically as a sole trader. Additionally, you might want to also register for VAT so that your new company appears more established.

Establishing a company vs. setting up a sole proprietorship

Setting up a sole proprietor’s account:

Whether you are a sole proprietor or a conventional partner, you must prepare your accounts in accordance with accepted accounting practice.

However, the exact form of accounts is not determined by law. The result is that you are not required to produce a balance sheet.

However, it is advisable to do so in order to impress your tax inspector or bank manager and to keep a proper check on your company’s financial position.

If you don’t want to hire an accountant, you can do the accounting yourself.

Even if your business is very simple, you can set up your own accounting system using a spreadsheet, but generally, you should use an off-the-shelf software package.

If you have a turnover of over £85,000, you must register with HMRC’s Making Tax Digital (MTD) online reporting system, which means using software that is MTD-compliant.

Employing an accountant as a sole proprietor:

Choosing not to hire an accountant is not a requirement for sole traders.

Nevertheless, if the cost isn’t too high, you may want to consider it since it can assist you in dealing with the tax inspector.

Furthermore, it may help you obtain a mortgage to purchase a house or contribute to a pension plan if you need proof of income from your business.

Kreston Reeves‘ tax consultant, Jo White, says: “It’s a benefit to have someone who does this day in and day out.” A piece of data is only as good as the person entering it. Having that reassurance that what you are presenting to Revenue is correct is important.

What you need to know about tax and national insurance:

Sole traders pay two types of national insurance contributions (NIC). The Class 2 contribution rate for 2019/20 was £3.05 a week for those who earn over the lower threshold, and £6,515 for 2020/21.

Additionally, you pay Class 4 contributions as a percentage of your profits. Class 4 NICs in 2020/21 will be 9pc of profits between £9,568 and £50,270, with an additional contribution of 2pc of profits above that amount.

A sole trader’s business is not separate from his or her own identity.

Thus, your profits are added to any other taxable income you have and are subject to income tax if the total exceeds your personal allowance.

Rates of Income Tax (All Income Over Your Personal Allowance)

Bands of Weakening Taxes
£0 – £12,570 £0
£12,571 – £50,270 20% (Basic Rate)
£50,271 – £150,000 40% (Higher Rate)
£150,001+ 45% (Additional Rate)

 

In the financial year 2020/21

Attention: These are the income tax rates for England, Wales, and Northern England. There was a separate six-step tax band system in Scotland.

Statistic on UK sole traders and self-employed

A total of 6 million private sector companies are estimated to exist in the UK by 2020, of which 4.6 million do not have any employees (76%). The 4.6 million total was made up of 3.3 million sole proprietorships, 946,000 corporations, and 311,000 ordinary partnerships, according to the government.

Despite the fact that most ‘sole proprietorships’ are one-person operations, a small percentage do have employees – about 229,000 in 2020 (about 6.5% of the total).

Therefore, if you’re thinking of going it alone, you have a lot of company (so to speak…).

Over the last decade, the number of sole proprietorships has grown by 28% (c.783,000 additions), fairly evenly across all regions of the UK, although London and the South-West saw the greatest growth.

In the last 20 years, non-employing businesses have grown by 2.2 percent.

Microbusinesses vs. non-employers vs. total private sector businesses in the UK

  2000 2020 % change
Total No. of Private Sector Businesses 3,467,000 5,981,000 +72%
Non-employers 2,356,000 4,568,000 +94%
Micro businesses (0-9 employees) 9
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