When starting a business, there are various decisions to make and tasks to perform. One of the first questions to address is whether to run the business as a sole trader, whether to set up a partnership with others or whether to form a company. The way in which a business is operated will determine the taxes that are payable and legal obligations that must be met.
A person operating as a sole trader is in business for themselves. This is arguably the simplest way to run a business.
Registering with HMRC
A person operating as a sole trader will need to register with HMRC for Self Assessment if they have trading income of £1,000 or more. This is the total from all unincorporated businesses, not per business.
If a person is already registered for Self Assessment, for example, because they have investment income or income from property to report to HMRC, they do not need to register again. Rather, they will simply need to complete the Self-Employment pages of the return to report details of their business income.
If a new trader is not registered for Self Assessment, they will need to do so by 5 October following the end of the tax year in which they first became liable to register. For example, if a person started a business in 2024/25 and their turnover was more than £1,000, they will need to register for Self Assessment no later than 5 October 2025. A person can register via the Gov.uk website (see www.gov.uk/register-for-self-assessment).
A person who has previously been registered for Self Assessment, but did not file a return for the last tax year, will need to register again to reactivate their account.
Tax and National Insurance
A sole trader must pay income tax on their profits. Their profits form part of their total taxable income, which will be liable to income tax to the extent that it exceeds their personal allowance for the tax year. For 2024/25 and 2025/26, the personal allowance is £12,570. Income tax is charged at 20% on the first £37,700 of taxable income. Taxable income in excess of £37,700 up to £125,140 is taxed at 40%, and anything over £125,140 is taxed at 45%. Where adjusted net income exceeds £100,000, the personal allowance is reduced by £1 for every £2 of income in excess of £100,000, such that anyone with adjusted net income in excess of £125,140 does not receive a personal allowance.
Self-employed individuals must pay Class 4 National Insurance if their profits exceed £12,570. This is payable at a rate of 6% on profits between £12,570 and £50,270 and at 2% on any profits in excess of £50,270. Where profits exceed the small profits threshold (set at £6,725 for 2024/25 and increasing to £6,845 for 2025/26), no Class 4 National Insurance contributions are payable. However, the trader will earn a National Insurance credit which will provide them with a qualifying year for state
pension purposes. Sole traders with profits which are below the small profits threshold can opt to pay voluntary Class 2 contributions to build up their state pension entitlement. At £3.45 per week for 2024/25 (increasing to £3.50per week for 2025/26), this is a much cheaper option than paying voluntary Class 3 contributions, and may be beneficial if the sole trader would not otherwise secure a qualifying year.
Tax and Class 4 National Insurance contributions must be paid by 31 January following the end of the tax year. Once the tax and Class 4 liability reaches £1,000, payments on account must be made for future tax years.
VAT
A sole trader will need to register for VAT if their VATable turnover exceeds the VAT registration threshold of £90,000 in the previous 12 months, or is expected to do so in the next 30 days.
Records
The sole trader will need to keep records of their business income and expenses to enable them to work out their taxable profits. It is a good idea to have separate personal and business bank accounts to avoid personal and business expenses getting mixed up. The trader should also keep invoices, receipts, etc.
