Are you thinking of starting your own business but unsure whether you should be classified as self-employed or a sole trader? Many people use these terms interchangeably, but they have distinct meanings, especially when it comes to legal, tax, and financial implications.
Understanding these differences is essential to ensure you comply with the relevant laws, maximise your tax efficiency, and set your business up for success. In this comprehensive guide, we’ll explore the key differences between self-employment and sole trader status, helping you determine which category best describes your business activities.
What Does It Mean to Be Self-Employed?
The term self-employed refers to individuals who work for themselves rather than being employed by a company. If you earn money through your own business activities and are not on an employer’s payroll, you are considered self-employed.
Who Qualifies as Self-Employed?
You are classified as self-employed if:
- You control how, when, and where you work.
- You provide goods or services to multiple clients/customers.
- You take financial risks in running your business.
- You pay your own taxes and do not receive wages via PAYE.
- You do not have employment benefits like paid holidays or sick leave.
Self-employment covers a wide range of professions, including freelancers, contractors, gig workers, small business owners, and consultants.
What is a Sole Trader?
A sole trader is a specific type of self-employed person who runs their business as an individual rather than through a company or partnership. In legal terms, the business and the owner are considered the same entity.
Key Characteristics of a Sole Trader
- You run and own the business yourself.
- You are personally responsible for all debts and liabilities.
- You keep all business profits after taxes.
- You must register with HMRC and file a Self Assessment tax return annually.
- You can hire employees, but you remain personally liable for the business.
The sole trader structure is one of the simplest ways to start a business and is ideal for individuals offering services, such as consultants, tradespeople, designers, and small retailers.
The Key Differences Between Self-Employed and Sole Trader
Although all sole traders are self-employed, not all self-employed people are sole traders. Here’s how they differ:
| Aspect | Self-Employed | Sole Trader |
| Legal Status | Broad term covering all non-employees | Specific legal business structure |
| Business Entity | Can include freelancers, independent contractors, partnerships, and company directors | Business and owner are legally the same entity |
| Taxation | Pays taxes via Self-assessment | Pays income tax on business profits via Self Assessment |
| Liability | Varies depending on structure (e.g., limited companies have limited liability) | Personally responsible for debts and liabilities |
| Registration | No specific registration unless required for tax (e.g., VAT or CIS) | Must register as a sole trader with HMRC |
| Hiring Employees | Possible, depending on the business structure | Can hire employees but remains personally liable |
Pros and Cons of Being a Sole Trader
Before deciding to register as a sole trader, it’s important to weigh the advantages and disadvantages.
Pros of Being a Sole Trader
- Simple Setup: Registering as a sole trader is quick and straightforward.
- Full Control: You have complete decision-making power over your business.
- Lower Costs: No legal fees for company formation.
- Tax Benefits: You can offset business expenses against tax liabilities.
- Privacy: Unlike limited companies, your financial information remains private.
Cons of Being a Sole Trader
- Unlimited Liability: You are personally responsible for business debts.
- Higher Tax Burden: Sole traders may pay more tax than limited companies.
- Less Credibility: Some clients prefer to work with limited companies.
- Limited Growth Potential: Expansion options may be restricted.
How to Register as a Sole Trader in the UK
If you decide to operate as a sole trader, you must follow these steps:
- Check if You Need to Register
- If you earn over £1,000 per year from self-employment, you must register with HMRC for tax purposes.
- Register for Self Assessment
- Visit the HMRC website and sign up as a sole trader.
- You’ll receive a Unique Taxpayer Reference (UTR) to file your annual tax return.
- Keep Business Records
- Track your income, expenses, and profits for tax reporting.
- Consider VAT Registration (If Applicable)
- If your turnover exceeds £85,000 per year, you must register for VAT.
- File Your Tax Return Annually
- Submit a Self Assessment Tax Return before the January 31st deadline each year.
Tax Responsibilities for Self-Employed and Sole Traders
Both self-employed individuals and sole traders must adhere to tax regulations. Here’s what you need to know:
Income Tax
- Your tax is calculated based on profit after allowable expenses.
- Tax rates for 2023/24 (UK):
- £0 – £12,570 → 0% (Personal Allowance)
- £12,571 – £50,270 → 20% (Basic Rate)
- £50,271 – £125,140 → 40% (Higher Rate)
- Above £125,140 → 45% (Additional Rate)
National Insurance Contributions (NICs)
- Class 2 NICs: Payable if profits exceed £12,570.
- Class 4 NICs: 9% on profits between £12,570 and £50,270; 2% above £50,270.
Value Added Tax (VAT)
- If your annual turnover exceeds £85,000, you must register for VAT.
Should You Be a Sole Trader or Set Up a Limited Company?
If your business grows, you may consider switching to a limited company for benefits such as limited liability, tax efficiency, and credibility. However, this comes with additional responsibilities like company registration, filing accounts, and paying corporation tax.
Who Should Remain a Sole Trader?
Small businesses with minimal financial risks.
Freelancers, consultants, and tradespeople.
Individuals who want simplicity and flexibility.
Who Should Consider a Limited Company?
Businesses with higher profits (to benefit from lower corporation tax).
Those seeking limited liability protection.
Companies aiming for investment and growth opportunities.
Frequently Asked Questions (FAQs) About Sole Traders & Self-Employment
Is a sole trader the same as being self-employed?
Not exactly. All sole traders are self-employed, but not all self-employed individuals are sole traders. Self-employment is a broad category that includes freelancers, contractors, and business owners, while a sole trader is a specific business structure.
Do I need to register as a sole trader?
Yes, if you earn more than £1,000 per year from self-employment, you must register as a sole trader with HMRC and submit a Self Assessment tax return.
What taxes do sole traders pay?
Sole traders pay Income Tax on profits, National Insurance Contributions (NICs), and VAT (if turnover exceeds £85,000). Taxes are filed through Self Assessment.
Can a sole trader hire employees?
Yes, sole traders can hire employees but must register as an employer with HMRC and manage payroll, PAYE tax, and pension contributions.
What happens if I don’t register as a sole trader?
If you don’t register but earn over £1,000, you risk penalties from HMRC and may have to pay overdue tax and interest.
Final Thoughts
Understanding whether you should classify yourself as self-employed or a sole trader is crucial for tax compliance and business success. While all sole traders are self-employed, not all self-employed individuals are sole traders—so choosing the right structure depends on your business needs.
At Bloom Financials, we help entrepreneurs and freelancers navigate self-employment, register as sole traders, and optimise their tax strategies. Need expert advice? Contact us today to ensure your business is set up for success!
