A freelancer’s overview to being a self-employed sole trader

The first step to working for yourself is opting for an operating structure which complements your working style. And more often than not for those who want to get freelancing quickly, that structure is a sole trader, writes Mark Halstead, partner at Red Flag Alert, a data intelligence platform providing on-demand data on the financial health of UK businesses.

If you have the business acumen and industry understanding to commoditise your skills to make a living, such a self-employed way of working may be ideal for you.

Sole trading: in a nutshell

Working as a sole-trader, also known as a sole proprietorship, is a straightforward operating structure which enables you to run your business on an individual level, rather than as a separate legal entity. The sole trader structure allows you to seize control and run your business exactly as you wish, without any interference or excessive reporting responsibilities.

A sole proprietorship means retaining the highest level of control and influence over your business, without the responsibility of managing a separate business entity, as is the case with a limited company. This brings a host of advantages and disadvantages which I’ll explore below, exclusively for FreelanceUK, helping you make an informed decision on how to operate.

What is a sole trader?

A sole trader is the sole owner of the business and is therefore personally liable for any business debts as there is no legal distinction between the individual and the business.

Both will be legally recognised as one and because there is an unlimited liability, you will be personally responsible for fulfilling any financial commitments, including any outstanding payments to creditors.

What are asole trader’s financial reporting duties?

The freedom and flexibility of working as a sole trader mean that your financial reporting duties to HMRC will be significantly less to that of a limited company. As a sole trader, you will only need to keep track of the following:

Self-assessment tax return
Income, spend and expenses

Which taxes do sole traders have to pay?

As a sole trader, you will pay Income Tax and Class 2 and Class 4 National Insurance Contributions (NIC) on business profits. The 2021-2022NIC rates for the sole traders are:

Class

Rate for 2021- 2022tax year

Class 2

£3.05 per week

Class 4

9% on profits between £8,569and £50,270 2% on profits over £50,270

By claiming the relevant expenses if allowable, this reduces profits, which in turn reduces the level of income tax due. Any expenses claimed will be recorded in your self-assessment tax return, such as mileage, fuel and subsistence. You will be required to retain receipts for expenses claimed. But this can be achieved easily by you using a cloud accounting software which will likely be compatible with the government’s Making Tax Digital programme.

Do sole traders have to register for VAT?

You will be required to register for VAT once your turnover reaches or exceeds the VAT registration threshold -- £85,000 for the 2021/2022tax year. You can voluntarily apply to register for VAT before meeting the threshold if you are working with other VAT-registered businesses and would like to reclaim VAT.

How do I set up as a sole trader?

You are required to inform HMRC of your self-employed status, regardless of whether you have any freelance jobs or self-employed contracts secured or not. If you are running your own business by providing paid services to multiple customers and you decide how to conduct the work, where and when, you are typically classed as a sole trader.

If you delay or fail to inform HMRC of your self-employed status, you risk receiving a severe penalty. This process of notifying the Revenue should be done by October 5th of the tax year you became self-employed.

However, it is an accountant who will typically take care of informing HMRC of your employment status and manage your financial affairs, including preparing and submitting your self-assessment tax return.

What do I call my sole trader business?

You can use your name or establish a business name. However, you must follow strict guidelines. Names used by sole traders must not:

end in ‘limited’, ‘Ltd’, ‘limited liability partnership’, ‘LLP’, ‘public limited company’ or ‘plc’
cause offence
replicate an existing trademark
contain a sensitive word
connect with government or local authorities

To use official terminology in your name, such as ‘accredited’, you need permission from the relevant authority. For example, you will need to contact the Department for Business, Energy and Industrial Strategy (BEIS) to use ‘accredited’ in your company’s name. If you would like to stop other businesses from using your name, you will need to register your name as a trademark.

What are the benefits of working as a sole trader?

There are many, but four fundamental advantages of being a sole trader are as follows:

The set-up process is fast, minimal and cheaper in comparison to setting up a limited company at Companies House to incorporate your business.

Accountancy fees are typically cheaper as there are less statutory documents to be submitted and fewer duties to fulfil.

After the deduction of taxes, the remaining money will be yours to use.

As a sole trader, you will not be affected by the IR35 legislation, the IR35 reform in the public sector and the incoming IR35 private sector reform, as this only applies to limited company freelancers.

What are the disadvantages of working as a sole trader?

There is an unlimited liability so your personal property and belongings will not be protected, putting you in a position of personal financial risk if things go wrong.

Larger businesses may be more inclined to trade with limited companies over sole traders as they are viewed as more credible, experienced and a larger entity than their sole trader counterparts.

After hitting a certain threshold, it may no longer be lucrative to continue working as a sole trader.

Sole trader V Limited company

Working as a sole trader can provide the freedom that you need to work creatively and innovatively. In comparison to a limited company, there are fewer duties and responsibilities to fulfil as a sole trader. As your business is unincorporated, your details won’t be publically displayed on Companies House, so you will be able to keep your address and ownership details private.

When operating as a limited company, you will be responsible for the daily running of the business and the submission of financial paperwork. As a result, you may find yourself paying a recurring monthly fee to an accountant to maintain your financial records. As the director of a limited company, you are technically an employee, whereas working as a sole trader gives you complete autonomy as you are your business.

When in doubt...

As you can see, each operating structure holds its own set of risks and rewards. My recommendation is to seek advice from an accountant or professional adviser to determine how to make the most of your money and hard work. Your duties as either a business owner or company director will vary, so educate yourself on which entity suits you better and then, get freelancing!