Over the next few days, we will be publishing a series of three articles which will help you to decide upon the best way to set your new business up – sole trader, Limited Company or Partnership.
In this article we will look at the Sole Trader option…
Becoming a sole trader is the most common route for individuals when starting a new business. The reason for this is because it is usually the easiest option, with fewest legal requirements. In addition, if you wish to start your business on a part-time basis, this option is ideal.
There are several elements to look at when deciding which legal format your new business should take and it is important to have an understanding of how your choice of format will affect each of these elements.
How do I set up as a sole trader?
Setting up as a sole trader is extremely easy. You simply decide upon a name for your business, such as ABC Plumbing and your legal business name becomes Bob Smith trading as ABC Plumbing (obviously replace Bob Smith with your own name!!).
You don’t even have to trade under a ‘trading as’ name, if you want to go about business using just your own name, then that’s fine. Note that if you do trade using a trading name, you must put your own name and business address on your headed paper and other stationery.
It is not necessary to formally register your business name with anyone, but you do need to advise the Inland Revenue about your new self-employed status so that they can update their records in respect of your income tax and National Insurance contributions. It is a legal requirement that you do this within 3 months from the end of the month in which you became self-employed. If you don’t do this, you are liable to a fine.
If you plan to start your business on a part-time basis, whilst still employed in another job, you should also let your tax office know. It is likely that they will merely make a note on their records and then ask you to fill in a self-assessment form at the end of the tax year so that you can declare the additional income earned from your own business.
Sole traders are personally responsible for all debts accumulated on behalf of the business. This liability is unlimited and an individual’s personal assets, such as their house or car, may be seized and sold in order to pay off business debts (subject to the necessary court orders of course). Ultimately, if a business fails and the sole proprietor is unable to repay the business debts, even after the sale of his/her assets, then he/she may be made bankrupt. Be under no illusion – if you are a sole trader and you incur business debts, you are the one that is liable to pay them back.
As a sole trader, you will pay income tax at the normal rates – the same as if you were employed – based on the profit of your business.
National Insurance is paid in two ways when you are a sole trader. Firstly, you pay ‘flat-rate’ Class 2 contributions and secondly you may have to pay Class 4 contributions. Class 4 contributions are based on your profits and are paid as a percentage of your profits.
If you choose to operate as a sole trader, there is no legal requirement for you to have your accounts professionally prepared or audited. You are quite free to do all the book-keeping yourself. However, you may find that employing an accountant or qualified book-keeper is beneficial when preparing your tax return or if you need to prove your income at any point, for example in order to obtain a mortgage.
In my experience, the majority of business owners are not accountancy experts anyway, so as well as getting rid of a, quite frankly, boring job, employing a professional can cost less than doing the work yourself, especially if they manage to save you some tax.
In terms of business credibility, many would consider a sole trader to be at the bottom of the pile. A business trading as a sole trader implies a small concern, rather than a substantial company. This is often completely incorrect – I know several sole traders that make profits of over £100,000 a year – well in excess of many limited companies. Sometimes a sole trader simply doesn’t want the additional ‘hassle’ of setting up a ltd company. Unfortunately however, it is a fact that if you intend to sell or deal with large companies, you may find that you have more credibility (rightly or wrongly) if you are using a ltd company to trade from rather than as a sole proprietor.