If you earn more than £1,000 from self-employment each year, you will need to set up as a sole trader. Fortunately, this is a simple process and, once you’ve chosen a name for your business, the next step is registering to pay tax through self-assessment. Once registered, you will have to submit a tax return each year.
For example, if you earn more than £1,000 through self-employment in the tax year 2022/23 (from 6 April 2022 to 5 April 2023), you will need to register as a sole trader.
There are other ways to set up your own business, such as registering a limited company or a business partnership, so it’s worth checking which company structure could be right for you.
Setting up as a sole trader
When you first register as a sole trader, you’ll need to do the following:
- Choose a business name.
- Register for self-assessment.
- Find out what records to keep.
- Get to grips with expenses.
- Manage your accounts.
- Verify if you need to pay VAT.
- Consider opening a business bank account.
You can find out more about each of these processes in the sections below.
Choose a business name
When you’re a sole trader, you can trade as yourself or pick a separate name for your business.
However, there are some rules to follow when choosing a business name. You should:
- Avoid certain words: As a sole trader, you must not include ‘limited’, ‘Ltd’, ‘limited liability partnership’, ‘LLP’ or ‘public limited company’ in your business name.
- Keep it clean: You must avoid offensive language.
- Check if you need permission: You may need permission to use certain words or suggest connections with local or national government – you can check here.
- Consider registering a trade mark: If you register your business name as a trade mark, it may be harder for other businesses to copy you.
You do not need to register your business name with Companies House. However, you must include your name (and your business name, if it’s different) on official documents such as invoices. What’s more, it’s good practice to be consistent so that your clients always know who is contacting them.
Register for self-assessment
Part of setting up as a sole trader involves registering to pay tax through the self-assessment system. You can submit tax returns to HM Revenue & Customs (HMRC), and also pay any tax and National Insurance contributions (NICs) you owe through this system.
Paying your tax this way is different to the Pay As You Earn (PAYE) system, which is used for employees of a company. This is where your tax and NICs are automatically deducted from your pay each month.
You will also need to set up as a sole trader if you need proof of self-employment or if you want to voluntarily pay Class 2 NIC contributions to help qualify for benefits and the state pension.
You can register for self-assessment on the Gov.uk website. You can file your tax return using the government’s online service, send paper forms by post, or use commercial software.
If you’re new to self-assessment, you must register by 5 October in your business’ second tax year. So if you earned more than £1,000 from self-employment in the last tax year (6 April 2021 to 5 April 2022), you should have registered for self-assessment by 5 October 2022.
If you missed the deadline to register for self-assessment for the tax year 2021-22, you should contact HMRC as soon as possible. You may have to pay a penalty if this means you end up filing your return and paying late.
The deadline to file your tax return online and pay any tax you owe for the 2021-22 tax year is 31 January 2023. The deadline for filing a paper return has already passed (31 October 2022).
Find out what records to keep
One of your responsibilities as a sole trader is to maintain accurate records of your financial activity. This includes your business income and expenses, as well as your personal income.
You must keep:
- proof of business sales and income
- records of allowable expenses
- VAT and PAYE records, if applicable
- records of your personal income
- records of funding you have received, including through the Self-Employment Income Support Scheme set up during the Covid-19 pandemic
You should keep records for at least five years after the online self-assessment deadline of each tax year, in case HMRC asks to see them at a later date.
For example, if you submit a tax return by 31 January 2023, you will have to keep your records until at least 31 January 2028.
You don’t have to submit these records with your self-assessment tax return, but they can help you work out the profit or loss you need to declare.
Get to grips with expenses
If you buy items that are essential to the running of your business, you may be able to claim these as ‘allowable business expenses’. As a sole trader, you can deduct the value of these purchases from your income to work out your taxable profit.
For example, imagine your business had an income of £25,000 and allowable business expenses worth £4,000. You could subtract these allowable expenses from your income, making your taxable profit £21,000. This would be the amount you pay tax on.
Allowable expenses include paying for stationery, staff uniforms, travel costs, such as fuel or rail tickets (used for business travel), and fees for training courses. It can also include recurring costs, such as business bank account fees and business energy bills.
If you work as a sole trader from home, you may also be able to claim a percentage of your domestic bills, such as heating, electricity, council tax and broadband costs, as allowable expenses.
Manage your accounts
You can manage and track your finances through one of two accounting methods.
- Traditional accounting: Record income and expenses on the date you send an invoice or are sent a bill.
- Cash basis accounting: Record income and expenses when you receive the money or pay for goods and services.
If you run a small business with an annual turnover of £150,000 or less, it’s likely that you can use cash basis accounting. This means you only pay income tax on money you have received in your accounting period – you don’t have to account for money you have invoiced but have not yet received.
If you feel you may need some help or advice with your accounting, consider consulting an expert, such as a bookkeeper or accountant, who can advise you on a method to suit your business.
Verify if you need to pay VAT
If you’re a sole trader based in the UK, you must register for VAT if you have an annual turnover above £85,000.
You have to register if your taxable turnover for the last 12 months was above £85,000, or if you expect to exceed this in annual turnover in the next 30 days.
You can also choose to register for VAT if your annual turnover falls below this threshold. You may consider this if you want to sell to other businesses that are registered for VAT and then reclaim the VAT, for example.
There is more information about the criteria for registering your business for VAT on the Gov.uk website.
Consider opening a business bank account
When you’re a sole trader, you don’t legally need a business bank account. If you feel it’s more suitable for you, you can technically use your personal current account for your business and personal finances.
However, there are benefits to having a business account for your self-employment income. For example, keeping your professional and personal income separate means you can easily see which self-employed expenses relate to your business, so it may be easier to complete your self-assessment tax return.
But bear in mind that if you run a limited company then a business bank account is compulsory. Your company must be incorporated with Companies House, which means it becomes a separate legal entity – so it needs its own business bank account.
Image source: Getty Images
All VAT-registered businesses are now required to comply with Making Tax Digital, and, by April 2027, many other businesses will need to keep digital records and file their tax returns digitally. Find out everything you need to know about this government scheme and what it means for you.