For some independent workers, the difference between being self-employed and being a sole trader may seem unimportant. In legal and practical terms these are both the same thing.
However, they are perceived to be different with a sole trader running a business that may be buying and selling goods, whereas self-employed is often applied to an individual working on a freelance basis and selling their own time and services.
What is self-employment?
If you are self-employed, you work for yourself and run your own business; you do not work for an employer. You pay tax through self-assessment, and there is no holiday leave or sick pay. For the purposes of tax and employment law, self-employment means full responsibility for the success or failure of your business.
What is a sole trader?
Sole trading is a way to run a business. A sole trader is a self-employed individual who is the exclusive owner of their business. Sole trader businesses do not have directors and do not need to register with Companies House. Because sole traders are self-employed, they must pay tax through self-assessment.
Perhaps most importantly of all, the identity of the sole trader is indistinct from the identity of the business. In other words, legally speaking, the two entities are one and the same.
Bookkeeping and day-to-day running of the business are straightforward, and all profits after tax are retained by the owner. However, you are also liable for debts run up by the business, as well as for any losses made by the company.
For some small business owners, a less risky strategy is to register as a limited company instead.
Self-employed vs. sole trader: what’s the difference?
A sole trader and being self-employed is basically the same thing. You as a sole trader run your business as a self-employed person. It is your responsibility to manage the success of your business.
As we have seen, there is a crossover in the sense that all sole traders are self-employed—but not all self-employed individuals are sole traders and may be set up as a limited company as we discussed above.
Make sure to take time to research how to get the most of your business bank account.
What are my responsibilities as a sole trader or self-employed person?
Both sole traders and self-employed individuals are responsible for submitting an annual tax return, as well as for paying income tax on profits and contributing toward National Insurance. If your business has employees, you are legally obligated to take out employers’ liability insurance.
It’s worth noting that there is no requirement for business insurance if you are a single-employee company, unless the profession itself demands a policy be taken out under a regulatory body. However, you may well consider taking out certain kinds of insurance regardless.
If you are a self-employed sole trader, you may wish to consider taking out public liability or professional indemnity insurance. Such a policy will protect you as the business owner against litigation taken against you by a customer, client or other third party.
As a sole trader, your profits are added to taxable income and therefore subject to income tax if the total exceeds your Personal Allowance. Additionally, you must pay two types of National Insurance.
If your business is earning above £6,365 per annum, you must pay weekly Class 2 contributions at a flat rate of £3. You also need to pay Class 4 contributions as a percentage of your profits. This rate currently stands at 9% for profits between £8,632–£50,000, with an additional 2% paid on any profits exceeding this upper threshold.
How to register as a sole trader
If you’ve decided that setting up as a sole trader is the best course of action for your business, the process is straightforward. You need to notify HMRC that you are self-employed and that you intend to register for self-assessment to pay tax.
You may then proceed with your business. You might also wish to register for VAT to lend credence to your company reputation, and it can be worthwhile to set up a specific sole trader bank account. Read our guide on sole trader bank accounts for more information.
Starting out as a small business owner can be daunting, but by practicing due diligence, conducting careful research and by understanding self-employment and sole trading, you will set a solid foundation on which to build your company.