Freelancers' Questions: What are the pros of being a sole trader?

Freelancer’s Question: In trying to get my head around the tax position of being self-employed, I came across this Freelance UK piece explaining that, due to tax legislation, recruiters don’t usually engage sole traders. In terms of pros and cons, this seems to me like a definite con. But what are the pros of being a sole trader, or at least what are the perceived benefits?

Expert’s Answer: A sole proprietorship is typically a business owned and operated by one individual. A sole proprietorship is not considered to be a separate legal entity under the law, but rather is an extension of the individual who owns it.

The owner has possession of the business assets and is directly responsible for the debts and other liabilities incurred by the business. The profit or loss of a sole proprietorship is combined with the other income of an individual for income tax purposes.

A sole proprietorship is perhaps the easiest form of business to own and operate because it does not require any specific legal organisation, except, of course, the normal requirements , extending to licences and permits. A sole proprietorship typically does not have any rules or operating regulations under which it must function. The business decisions are solely the result of the owner’s abilities.

Pros of being a Sole Trader

- There are no formation costs

- Sole traders are not required by law to have annual accounts nor to file accounts for inspection. However annual accounts are necessary for tax returns

- Sole traders are unrestricted in the amount and purpose of borrowings (but cannot create floating charges)

- Losses generated by a sole trader can be set against other income of the year or carried back to prior years.

Tax make-up of a Sole Trader

- For a sole trader, tax is generally paid by instalments on January 31st in the tax year, and July 31st following the tax year. For an ongoing business, tax for 2011-12 is payable: first payment on January 31st 2012, second payment on account on July 31st 2012, with any final due on January 31st 2013

- A sole trader will pay Class 2 NI of £2.50 a week and Class 4 NI, depending on their level of profits

- Profits are taxed at 40% on taxable income in excess of £35,000 and at 50% over £150,000 (2011-12).

The expert was Martin McKechnie, of The Low Tax Group, whose comments were excerpted from its guide to financial, tax and accounting considerations for starting a successful business - The New Business Kit.

Editor’s Note: Further Reading –

Freelancers’ Questions: Do sole traders need a business account?

Freelancers’ Questions: Do sole traders have duties?