What do you need to know as a Sole Trader

When starting a business it is important to understand what business type you should adopt.  This article covers what a Sole Trader is along with the pros and cons of being such.

What is a Sole Trader?

A sole trader is an individual who decides to undertake an activity with a view to make a profit.  It is important to note that you are the business and the business is you.  There is no separation between the two.

When should you register as a Sole Trader?

If your total earnings in a tax year from your trade is £1,000 or less then you do not need to register.

Otherwise you should register with HMRC as soon as possible but the ultimate deadline is the 5 October after the end of the tax year 5 April that you started work.

E.g. if you start working on 1 October 2023, the next tax year is 5 April 2024, so you would need to register by 5 October 2023.  Please be aware with Making Tax Digital this may change.

How to Register as a Sole Trader?

In order to register as a sole trader it is important to ensure that a CWF1 form is completed.  You must register even if you are already in the Self-Assessment system.

The reason why a CWF1 is required is to ensure you are registered with the National Insurance Office for Class 2 National Insurance, which enables you to earn qualifying years for a State Pension (provided your business profits are sufficient).

What is my potential liability?

As a sole trader you have unlimited liability.  It is therefore important that you have the appropriate insurances to ensure you have adequate cover for any eventuality.

A business debt or liability is therefore a personal one.  This means any personal assets are at risk from creditors if you were to cease trading with debts.

What taxes do you pay?

If you have not already used your personal allowance, for the 24/25 tax year the first £12,570 is tax and Class 4 National Insurance free.

The tax rates are 20% (basic rate), 40% (higher rate) and 45% (additional rate).

Class 4 National Insurance is at 6% between £12,570 to £50,270 of profit.  Above this the rate drops to 2%.

The benefits of Self-Employment
  • Immediate start, so you do not have delay in beginning your business idea
  • Simplicity with this having the least amount of admin and compliance other structures have
  • Privacy – only you and anyone you wish to share it with knows how much you are earning and what wealth you have.  Other types of business have to show information on Companies House
  • Claiming of expenses – you can claim anything that has a business element
  • You can claim your business proportion on your car or claim the statutory amount of 45p per mile
  • All earnings qualify as earnings for pension purposes
  • You have full control of how your business is run and the decision-making
  • If you have a rental property and are VAT registered you may be able to claim VAT on your rental costs via the partial exemption rules
The downsides of Self-Employment
  • You may have higher tax bills, as you pay tax and National Insurance based on the profit you make (even if you do not need it all to live off) – although you may be eligible for the annual maxima test if you have other employed or self-employed income
  • Unlimited Liability, so it is imperative you have a good insurance policy
  • Look smaller to other businesses that may put them off with trading with you
  • Making Tax Digital is being introduced for all businesses but the Self-Employed are due to be one of the first to have to comply
  • Finance: it can be harder to get loans both for business and personal purposes. It can sometimes be harder to get a mortgage
  • The pressure for a business to succeed is placed on an individual’s shoulders
  • If you work from home, your home address may be visible e.g. on invoices, internet advertising
What is my year end and deadlines?

The simple answer is that you should have a year end of 31 March or 5 April.  HMRC are planning on ensuring all sole traders work out their profits to this date. It therefore makes sense to adopt that date now.

The deadline to submit your tax return is 31 January after the tax year.

When do I pay my tax?

The payment dates of tax are the 31 January after the tax year end and then if applicable the 31 July.

When you first start trading you do not make any tax payments until the 31 January after the end of the tax year you started trading.  If you started trading on 24 April 2022, you will first pay tax on 31 January 2024.  It is important to budget for your tax.

The 31 January date is the date you make your 1st payment on account and any balancing payment to settle a tax liability.  The 1st payment on account is due when we are 10 months through the current tax year, so if you are in the payment on accounts system (generally if you have a tax liability of £1k+), HMRC require a payment of effectively 6 months of tax, estimated on your previous year’s profit.  If after making the 2 payments on account you have underpaid you will make your balancing payment.

The 31 July is the date of the 2nd payment on account, which is 4 months after the tax year, so HMRC require the next 6 month instalment, which in theory settles your tax liability.

If you are due a repayment you should receive this within a few weeks of the tax return submission.  Alternatively you could reduce your 2nd payment on account down if you transmit in your tax return before 31 July.

There is the ability to reduce payments on account if you think the next year will not be as profitable.  You must be careful to not reduce these down too much.

What is Making Tax Digital

HMRC are promoting this as a positive change replacing the annual tax return.  Instead a taxpayer has to submit 4 quarterly updates before making a final submission (so 5 in total).  HMRC also say it will help their customers budget for their tax.  We will let you decide which system sounds easier for the self-employed.

Making Tax Digital is coming in for all business and individuals in some form, but for the Self-Employed the proposed start date is April 2024, however this date has been delayed previously.

If I am making Quarterly updates will I have to pay my tax sooner?

The official answer is that there are no current plans to bring forward the payment date for tax.  Although you would expect it will come in at some stage in the future.

Contact us

This article is not exhaustive, but covers some of the important aspects of being a sole trader.  If you are thinking of starting a business and want to discuss which option is appropriate for you, or you need assistance in filling out a cwf1 form, please contact us and a member of our team will be happy to help.

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