When you start your own business, you’ll need to decide which company format to register with HMRC. The structure you register your company under will depend on how much legal and financial responsibility you want to take for the business. Setting out in business on your own might feel daunting, but take comfort from the fact that you’re in good company - there are now almost five million self-employed workers in the UK, accounting for 15% of the total workforce! There are many benefits of being your own boss, including greater control over your work-life balance, flexible hours and choice on the projects you work on. However, there are a few things you should know before you start trading. Here’s a quick guide to keep you on track.
1. Registering as a sole trader is easy
Starting as a sole trader is easy. You'll need to register for self assessment to pay sole trader tax. Self assessment is the system HMRC uses to collect income tax. Registering to become a sole trader can be done online very quickly. If you haven't registered to become a sole trader before, after registering, HMRC will send you a letter with your 10-digit Unique Taxpayer Reference (UTR) and set up your account for the self assessment online service. You'll need your 10-digit UTR from when you registered before. You can find out your UTR if you don't know it. You'll need to register with HMRC for the Construction Industry Scheme if you're working in the construction industry as a subcontractor or contractor.
2. You can be fined for not registering with HMRC
As soon as you become self-employed, you should register with HMRC. The latest you can register with HMRC is by 5 October after the end of the tax year during which you became self-employed. The tax year runs from 6 April one year to 5 April the next. Register too late to pay sole trader tax or not at all and there can be severe penalties.
3. Being a sole trader involves some personal financial risk
As a sole trader, you are the business. It's not a separate legal entity, as it would be if you formed a limited company. Therefore, you're liable for your business's debts. If you're starting a business that won't build up big debts, becoming a sole trader isn't too risky. If you are likely to build up significant debts, setting up a limited company would be a less risky option.
4. Sole trader tax admin costs are usually cheaper
You have to pay to set up a limited company and running it requires slightly more administrative effort when it comes to tax. Registering as a sole-trader costs nothing, while accounting costs and tax liabilities are likely to be cheaper than if you started a limited company.
5. Sole traders can still employ people
But if you do employ people, you must collect income tax and National insurance contributions (NICs) from them and pay these to HMRC. You'll need to operate a PAYE (Pay As You Earn) payroll scheme for this purpose.
6. Sole trader tax is simple enough to understand
You pay Income tax based on your business profits. You (or your accountant) must fill in a self assessment tax return each year, detailing your income and expenses. You'll also have to make flat-rate Class 2 NICs throughout the year (£3.05 a week). If your annual profits are more than £9,568 (2021/22), you'll also have to pay Class 4 NICs (9% on profits up to £50,270; 2% on annual profits above this figure - 2021/22). You pay this with your income tax and the figure is calculated from your self assessment tax return.
7. Sole traders must always keep detailed financial records
That includes details of all your sales. You must also keep proof of any expenses (eg receipts, invoices, utility bills, etc for any stock and supplies or other outgoings you might have). These will help when filling in your tax returns
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8. Some sole traders must be VAT-registered
If your turnover exceeds the VAT threshold (currently £85,000 a year), you will need to register for VAT. When you're VAT registered, you charge your customers VAT on VAT-able sales and pay it to HMRC. In turn, you can reclaim the VAT you pay on goods and services you buy.
9. Sole trader businesses can become limited companies
The size and nature of your business can change quickly. And for a range of reasons (including increased exposure to risk) you might want to set up your own limited company at a later stage. Providing someone else hasn't already registered the name, you should be able to use your sole trader name (with Ltd added, of course).
10. 31 January and 31 July are key sole trader tax dates
The deadline for Sole traders to pay tax is on the 31 January following the end of their tax year. Crucially, HMRC will request payments on account for the following year's estimated tax - on 31 January and 31 July each year. That means, after your first year in business, your tax bill could be 150% of what you were expecting to pay, with another 50% payable in July.
Here's a bonus tip :)
11. Put money into a sole trader tax fund bank account each month
When its time to pay HMRC, you'll be glad you put a few quid away each month. Being faced with a large tax bill you haven't saved for is a nightmare. Try to put 25% of your earnings into a separate bank account (and don't dip into it). Failing to pay your tax bill on time will result in penalty charges.
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Good luck on your new journey !