Becoming a sole trader – what do I need to know?

Becoming a sole trader – what do I need to know?

Self-employed people made a massive £366 billion contribution to the British economy last year and there were more than 3 million of them, amounting to just over half of all businesses.

Their number is growing and it is easy to see why: going self employed is by far the easiest way to start in business as it can fit in around existing family or work commitments. All you have to do is set up shop and start trading – but let the taxman know of course.

However, despite the relatively simplicity of going down this route, there are things every self-employed person should know.

Staff

If your business is growing fast you will be pleased to hear that sole traders are allowed to take on workers. However, you must register with HMRC as an employer before your first payday. HMRC will then send you your employer PAYE reference number.

Becoming an employer is a big step and creates a number of obligations. You have to comply with minimum wage regulations, set up a pension scheme and pay national insurance. If you have fewer than 10 employees you can use HMRC’s free Basic PAYE Tools payment software, which will perform most payroll tasks for you.

Choosing a name

Perhaps surprisingly, this is not necessary. However, if you do want to give your business a name it must comply with some rules, such as it must not use the designations ‘Ltd’ or ‘LLP’ and names must not be offensive or suggest a link with the government or local authorities unless you have their permission to do so.

HMRC and tax

You will have to register with HMRC to do your annual self-assessment tax return. Navigating the tax return document, which is about 20 pages long, can be challenging for new starters and it is well worth considering handing it over to an accountant to do. Most firms have good value fixed-price deals for tax returns, and will be able to maximise the amount you can claim on expenses and spot any allowances you are due, thus cutting your tax bill to the minimum.

As a sole trader you pay income tax on your profits at 20% up to £50,270 and 40% on profits above that, with additional rate tax at 45% starting on profits above £125,140. The personal allowance means you don’t pay tax on your first £12,570 of earnings and you can also claim a £1,000 a year trading allowance.

If your profits are over £12,570 you should pay class 4 national insurance at 6%. If your profits are less than £6,725 you can choose to pay class 2 national insurance contributions, which will protect your national insurance record and pension entitlement.

The deadline for filing your tax return and paying whatever is due is 31 January for the tax year that ended the previous 5 April. HMRC will add on what it estimates is about half your next bill as a payment on account and another payment on account is due by 31 July. Be sure to budget for these payments.

Insurance and banking

If you have employees it is a legal requirement to have employers’ liability insurance. This will cover any compensation claims against you if an employee becomes ill or injured due to the work they do for you.

Public liability insurance covers legal costs if someone makes a claim against you relating to an injury or damage to their property caused by your business activities.

You might also consider professional indemnity insurance that protects you against negligence claims by customers or clients, and income protection insurance that will provide you with an income if you cannot work due to injury or illness.

Unlike a limited company you do not need to set up a business bank account (which usually come with monthly fees); however, it makes sense to operate an account solely for the business to stop personal and business finances getting muddled together.

VAT

Sole traders whose turnover is more than £90,000 in any 12-month period or is going to exceed this amount within the next 30 days must register for VAT with HMRC. Once registered, they have to file a VAT return every quarter and charge customers VAT on sales (output VAT) but can claim back VAT (input VAT) on things they buy for the business.

Record keeping

It is essential to keep a record of all the money coming in and out of the business. This includes proof of sales and income, your allowable expenses and VAT and PAYE records if applicable.

As well as making it much easier to complete your tax return, good record keeping will enable you to track how well your business is doing against your targets and forecasts. It will also act as an early warning system, for example, if a client is a late payer or there are parts of the year when trading is poor, that will help you with budgeting and forecasting.

You must store your financial records for at least five years after the submission deadline for the relevant tax year. Thus 2024-25 records must be kept until February 2031.

It is worth noting that as a sole trader your financial records only need to be shared with the taxman; an advantage over limited companies, which need to publish their accounts.

Expenses

HMRC allows self-employed people to claim expenses for things like:
• staff costs;
• stock;
• financial costs such as insurance or bank charges;
• rent and rates;
• advertising and marketing;
• training courses;
• equipment and special clothing.

The money spent on these is deducted from profits, thus reducing the annual income tax bill. People who work at home may also deduct a portion of the running costs of their household from their tax bill.

The trading allowance mentioned above is not available if actual costs are claimed, traders should pick one or the other depending on which cuts their tax bill the most.

Some disadvantages of being a sole trader

There are some important downsides to becoming a sole trader.

First of all, sole traders have full liability for all debts they incur as distinct from an LLP or limited company, where the debts stay with the partnership or company. Legally, the self-employed person and the business are one entity.

It is often more difficult to raise finance as investors prefer the more regulated structure of a company or LLP and the greater visibility they have of the entity’s finances. A sole trader can seem a bit here today, gone tomorrow and less reliable than its alternatives.

Self-employed people who start doing well will probably pay less tax if they set up a limited company as corporation tax and dividend tax rates are lower than income tax rates. And the tax regulations governing companies allow for more opportunities for efficient tax planning.

A sole trader’s business is likely to sell for less than an equivalent company as it seems less tangible, and goodwill and any brand value will be discounted as they will be assumed to be indivisible from the sole trader who is selling.

That said, it is often the best entry point to the world of business due to its simplicity, low costs and lack of red tape. Being self employed is also great for people who may have some earned income already and just want a top-up or who have family responsibilities that make a full-time job impractical.

For those who like the sound of joining the UK’s growing army of self-employed people and enjoying the flexibility and rewards of being a sole trader but would like more bespoke advice, please contact Finsbury Robinson.

Whether you want advice on a business idea or a venture that is up and running, our team can help. We are a full-service tax, accountancy and business advisory firm, and our friendly and highly experienced staff are available on 020 8858 4303 or via email at info@finsburyrobinson.co.uk

Angus Walker 17/10/2025