Working for yourself as a self-employed and being your own boss is undoubtedly a thrilling concept since it gives you ample flexibility, power, and control to choose your own hours, work set-up, and financial rewards. Accordingly, this guide clearly outlines what is the difference between sole trader and self-employed so you can make rational decisions regarding registering and managing your business.
Similarly, when starting a business in the UK, many individuals wonder what is the difference between sole trader and self-employed. Although these terms are often used interchangeably, they have distinct meanings and impacts in terms of UK taxation and business structure.
While a sole trader is one of the most common types of self-employment, the two terms stand distinguished from each other. A sole trader is a specific term for a specific business model. Contrary to this, self-employment is a wider term incorporating different business options, referring to anyone who generates income without working for an employer.
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What is a self-employed worker?
The term self-employed refers to all the individuals who primarily work for themselves rather than an employer. Being self-employed allows you to be your boss.
It frees you from standing answerable to an employer and offers you immense control over your working life than traditional employees, e.g. you work and execute your business tasks of your own accord. The key features of being self-employed include:
While self-employment accompanies great independence and power, the credibility and earning potential of the business rely largely on endless motivation, business acumen, and keeping the trust of customers and clients intact. The key features of a self-employed worker include:
- They are solely responsible for managing their own business income and expenses.
- A self-employed worker must register their business status with HMRC and report their income every year.
- They pay income tax on the taxable profits and NICs to HMRC through self-assessment.
- Self-employed individuals are entitled to claim any paid holiday leave or sick pay. Under HMRC guidelines,
- For tax and employment law purposes, self-employed individuals bear full responsibility for all the consequences of their business, be it generating profits or spiralling down financially.
- Self-employed individuals do not receive a salary through PAYE (Pay As You Earn) system.
- They can operate as a sole trader, business partnership, or limited company.
It is noteworthy that an individual can be self-employed and employed at the same time. To clarify, if an individual does a full-time job in the day and runs an online business at night or in their spare time, they are regarded as employed and self-employed simultaneously.
What is a sole trader?
A sole trader is a self-employed worker owning a business in its entirety. In the legal context, having a sole trader status implies that the business and its owner are one and the same. As an outcome, having entire and absolute authority separates a sole trader from other self-employed individuals.
The prime features of a sole trader include the following:
- The business and the owner are legally the same entity.
- A sole trader individual is entitled to all the post-tax profits (the profits left after all tax obligations have been fulfilled). Hence, they alone retain all the profits the business generates.
- A sole trader is fully and personally responsible for all the business debts.
While most self-employed individuals usually prefer to opt for the business structure of sole tradership, there are also other options of self-employment an individual can choose from, such as a freelancer and a limited company. To learn more about the types of self-employment, read our guide:
What is the difference between sole trader and self-employed?
It is noteworthy that while all sole traders are self-employed workers, not all self-employed individuals are sole traders since there are also other business structures falling under self-employment. Consequently, there are key distinctions setting both apart. So, let’s understand what is the difference between sole trader and self-employed:
Business status:
Sole tradership describes a specific business structure where the individual and business are legally the same. On the contrary, self-employment is a broader and more extensive term that includes anyone who works for themselves and not an employer.
While self-employed people may or may not be sole traders, a sole trader is always and necessarily a self-employed worker running a specific business structure.
Business earnings:
Another crucial aspect when learning what is the difference between sole trader and self-employed is the earnings generated by the business. Going into detail, your annual income greatly impacts or determines whether you are a sole trader or a self-employed worker.
For example, if your annual earnings are above £1,000, you must register as a sole trader. On the flip side, no registration with HMRC is required if you just earn a few hundred pounds annually from a side business.
Legal status:
A sole trader is legally responsible for all business debts incurred. Conversely, the business and legal liabilities for a self-employed worker differs based on business structure, such as sole trader, partnership, or limited company.
Notably, unlike other types of self-employment, there lies no legal distinction between owner and company since a sole trader owns and runs their company themselves. Subsequently, they significantly benefit from pocketing in all the post-tax profits.
Liability:
As mentioned above, unlimited liability is an inevitable aspect of sole tradership. It signifies that a sole trader is personally liable for all the damages, losses, or debts their business incurs in the event the company goes insolvent.
Therefore, when a sole trader owes money, creditors can sue them personally and can even forfeit both business and personal assets. On the other hand, in self-employment, the liability depends on the business structure, like sole traders bear full liability, while limited company owners benefit from limited liability.
Taxation:
Self-employed individuals, including sole traders, must submit a self-assessment tax return every year based on the income tax bands their earnings fall into. Similarly, both sole traders and self-employed individuals pay NICs. Now, you would be wondering what is the difference between sole trader and self-employed regarding taxation then.
Well, a sole trader mandatorily submits their Income Tax through filing a self-assessment, whereas being broader in scope, a self-employed person’s tax liabilities exclusively depend on their chosen business structure.
For greater clarity, consider a self-employed person who runs a limited company. According to HMRC regulations, the profits of the limited company are taxed under Corporation Tax rules and are not included in your personal self-assessment tax returns.
Registration:
It is compulsory for a sole trader to register with HMRC as exclusively a sole trader. Opposed to that, while a self-employed person must register as self-employed, they can choose different business structures.
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Conclusion:
In summary, a sole trader is a specific type of self-employed individual who operates or runs a business as an individual entity. On the contrary, self-employed is a broader term that integrates sole traders, partners (partnership), and business owners (limited company).
However, both are obliged to register with HMRC, fulfil income tax and NICs, and maintain compliance with HMRC’s regulations. Therefore, learning what is the difference between sole trader and self-employed is crucial so you do not confuse the two with each other.
Accounting firms can help you thrive in business and streamline your tax concerns:
Moreover, if you are struggling with the question of whether to operate as a sole trader or explore other business structures, consulting a certified and professional accountant can considerably help you make an informed decision.
In this regard, an experienced accountant from Accountingfirms can give you comprehensive guidance in managing your self-employed status effectively while staying compliant with HMRC regulations. Whether you need tax filing assistance, business registration support, or VAT advice, we offer across-the-board financial and accounting services.
Thus, visit Accountingfirms to connect with qualified and skilled accountants to set your business on the right foot.
Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.