Sole Trader vs Self-Employed: Understanding the Differences

Sole trader vs self-employed…which is best? Terminologies like “sole trader” and “self-employed” are often used interchangeably, leading to confusion among those venturing into independent work. While both involve individuals working for themselves, there are subtle yet significant differences between the two.

Understanding these disparities is crucial for anyone embarking on a solo career path or considering setting up their own business.

In this article, we will explore what sole traders and self-employed mean and the differences between the two terms.

What is a Sole Trader?

A sole trader, also known as a sole proprietor, refers to an individual who owns and operates a business single-handedly.

In this structure, there is no legal distinction between the owner and the business entity itself. This means that the proprietor is personally liable for all aspects of the business, including debts, losses, and legal obligations.

Sole traders have complete control over their business decisions, from finances to operations, and they retain all profits generated by the business.

Key Characteristics of Sole Traders

• Singular Legal Entity: A sole trader operates under their own name or a chosen business name, but legally, they are one and the same.
• Tax Obligations: As a self-employed individual, a sole trader is required to pay tax through self-assessment.
• Profit Retention: All profits made after tax are kept by the sole trader. 
• Unlimited Liability: In a sole trader business, the business owner is personally liable for any debts or losses the business incurs.
• Flexibility: A sole trader has the freedom to make all decisions related to the business.

What is a Self-Employed Person?

A self-employed person is someone who earns their living by working for themselves, rather than being employed by a company or individual. They are essentially their own boss and take on the full responsibility for the success or failure of their business endeavours.

The Difference Between a Sole Trader and Self-Employed

The terms “sole trader” and “self-employed” are often used interchangeably, but there is a subtle difference between the two.

• Self-employed is a broad term that describes anyone who earns income without being an employee of a company. This means they don’t get a regular salary or benefits package, and they are responsible for paying their own taxes. Freelancers, consultants, and independent contractors are all considered self-employed.
• A sole trader is a specific type of business structure for self-employed people. It’s the simplest and most common setup, where you are the sole owner and operator of the business. There’s no legal distinction between you and the business – you keep all the profits after taxes, but you’re also personally liable for any debts.

Here’s an analogy: Think of “self-employed” as a category of employment, like “employed” or “unemployed.” “Sole trader” is a specific type of business within the “self-employed” category, like “salesperson” or “manager” is a type of employed position.

All sole traders are self-employed, but not all self-employed people are sole traders. There are other business structures for self-employed people, such as partnerships or limited companies. These offer advantages like limited liability protection but come with more complex setups and regulations.

Sole Trader Responsibilities

Being a sole trader comes with a wide range of responsibilities, encompassing everything from running the business itself to dealing with the financial aspects. Here’s a breakdown of the key areas:

Running the Business:

• Daily Operations: You’ll be responsible for all aspects of the business, from marketing and sales to customer service and production (if applicable).
• Decision Making: You wear the boss’s hat, so all the choices are yours, from what services to offer to how to price them.
• Hiring (Optional): While you can operate solo, you can also hire employees to help with specific tasks. You’ll then be responsible for managing them.

Financial Responsibilities:

• Record Keeping: Keeping accurate records of your income and expenses is crucial. This will be needed for tax purposes and to understand your business’s financial health.
• Taxes: As a sole trader, you’ll file a self-assessment tax return annually and pay income tax on your profits. You may also need to pay National Insurance Contributions (NICs). In some cases, you might also need to submit VAT returns. You do not have to submit a company tax return or pay corporation tax as a sole trader.
• Unlimited Liability: Unlike limited companies, your personal assets are not separate from the business. If the business runs into debt, you’ll be personally liable for repaying it, even if it means selling personal belongings.

Insurance Considerations:

Insurance plays a pivotal role in mitigating risks associated with a sole trader business. From covering legal costs to compensating for damages, the right insurance can be the difference between business continuity and financial ruin. 

• Public Liability: Not mandatory, but highly recommended. This protects you if a third party (customer, visitor) gets injured or their property is damaged due to your business activities.
• Employer’s Liability: Legally required if you hire any employees, even part-time or casual workers. This covers you if an employee gets injured or becomes ill at work.
• Professional Indemnity (optional): This is important for service-based businesses. This protects you from legal claims if a client alleges negligence or mistakes in your work that cause them financial loss.
• Other Considerations: Depending on your business type, you might also consider additional insurance like business equipment or property damage, product liability (if you sell goods), or even personal accident or income protection to cover yourself if you can’t work due to illness or injury.

Sole Trader vs Self-Employed

While the terms “sole trader” and “self-employed” are often used interchangeably, they represent distinct yet interconnected concepts in the realm of independent work. Self-employment encompasses a broad spectrum of individuals earning income without traditional employment, including freelancers, consultants, and independent contractors.

On the other hand, a sole trader is a specific business structure within the self-employed category, denoting a single individual owning and operating a business without legal separation from their personal assets.

For professional support in managing the financial aspects of your sole trader business, consider exploring Mazuma’s accounting services.