What is the Difference Between A Sole Trader and A Self-Employed?

Starting a business in the UK often leads to confusion about the difference between sole trader and self-employed status when compared to the independent self-employment category. The terms sole trader and self-employed are often confused as being synonyms, although they hold different definitions. The following guide explains the main distinctions between operating as a sole trader and being self-employed by examining tax rules alongside the legal and profit advantages of each business structure.

Need help with your Self Assessment Tax Return? Let us make it simple for you.

What Is A Sole Trader?

A sole trader is a specific type of business structure in the UK. It means you run your business as an individual by yourself, and you are personally responsible for its financial obligations.

Key Features of a Sole Trader:

You have exclusive ownership rights over your business entity.
You maintain complete authority to decide all business matters.
You keep all business profits after tax.
You are personally liable for business debts.
You must register with HMRC for Self-Assessment tax returns.
Businesses must register for VAT when their business hits £90,000 or above in annual turnover.

What Does Self-Employed Mean?

Being self-employed refers to anyone who works for themselves rather than being employed by a company. Sole traders together with freelancers and business partnership members fall under this category. How to register as self-employed, understand the procedure for self-employment registration to meet HMRC guidelines.

Key Factor of Being Self-Employed:

Self-employment means you function independently and not under the direction of any employer.
You may run a business as a sole trader or in another form, like a partnership.
You are in control of paying your tax and National Insurance.
You do not receive employment benefits like sick pay or holiday pay.

Key Difference Between Sole Trader And Self-Employed

Legal Status: A sole trader is a specific business structure, while self-employment is a general work status.

Business Ownership: A sole trader owns and runs their business, while self-employed individuals may not necessarily own a business.

Taxation: Both must file a Self-Assessment tax return.

Liability: The legal responsibility of business debts lies with sole traders while self-employed persons face different levels of liability based on their specific business structure.

Example: Small business owners and shop owners function as sole traders, whereas freelancers, together with sole traders and business partners, fall under the self-employed category.

Tax Answerable for Sole Traders and Self-Employed Individuals

In case you are a sole trader or just self-employed, you must pay tax on your income. Here’s what you need to know:

1. Registering with HMRC

Both sole traders and other self-employed individuals must register with HMRC for Self-Assessment.
HMRC provides a Unique Taxpayer Reference (UTR) number to you for managing your tax affairs.

2. National Insurance Contributions (NICs)

Sole traders and self-employed individuals must pay Class 2 and Class 4 National Insurance Contributions.
If your profits are below £12,570, you may not have to pay Class 2 NICs.
For the updated tax rate, visit the official website of HMRC

3. Value Added Tax (VAT)

Even if your business income exceeds £90,000 per year, you must register for VAT at HMRC. For more details on VAT, click here.
You can voluntarily register for VAT even if your turnover is lower, which can help with reclaiming VAT on business expenses.

4. Business Expenses

The deductible business expenses of both sole traders and self-employed individuals serve to decrease their taxable income.
Duplicate business expenses such as office costs, travel expenses and business insurance are typical deductions.

Pros And Cons Of Being A Sole Trader

Here are some points of pros and cons for a sole trader.

Pros of Being a Sole Trader:

Simple Setup: The Registering as a sole trader is quick and easy.
Full Control: As a sole trader, you make all business decisions.
Keep All Profits: If you are a sole trader, no need to share earnings with business partners.
Less Paperwork: There are a small number of legal and accounting requirements than those for a limited company.

Cons of Being a Sole Trader:

Personal Liability: You are personally responsible for all business debts.
Tax Rates: Higher personal tax rates than limited companies.
Limited Growth Potential: Some clients prefer working with limited companies rather than sole traders.

Pros And Cons Of Being A Self-Employed

Here are some outcomes of pros and cons of the self-employed.

Pros of Being Self-Employed:

Flexible Working: The self-employed have full freedom regarding their work schedule and method of completion.
Variety of Work Options: Self-employment offers multiple work options including operating as a freelancer or contractor or sole trader.
Potential for Higher Earnings: Self-employed workers have greater potential to earn more than employment wage limits.

Cons of Being Self-Employed:

No Employment Benefits: No sick pay, holiday pay, or company pension.
Irregular Income: Every month, you receive irregular payments since self-employment lacks guaranteed salary checks.
Complex Tax Responsibilities: Running a business as self-employed requires you to handle all tax requirements yourself.

Which One Is Right for You?

If you run a business on your own and want legal recognition, becoming a sole trader is the best option. Working independently without any registered business makes you considered a self-employed individual.

Consider these factors when deciding:

Launching your business under the sole trader status requires you to start by registering as a sole trader.
People who want to maintain flexibility without legal constraints should stay self-employed.
If you need to hire employees, a sole trader business can employ staff, but you must register for PAYE (Pay As You Earn).

Understanding the difference between sole trader and self-employed helps you choose the right path based on your work nature and financial goals.

Conclusion

All UK independent workers need an essential understanding of the difference between sole trader and self-employed. Every person who operates as a sole trader is considered self-employed, whereas self-employment does not automatically make someone a sole trader. Your selection of status depends on your work nature combined with liability considerations, together with financial goals.

Our firm employs professionals who deliver expert consulting services related to sole trader taxation. Contact us immediately. Professional guidance is available through our current contact service.