Nine steps for setting up as a sole trader

Setting up as a sole trader is one of the simplest ways to start a business. Nevertheless, there are still rules and regulations you must follow to ensure you’re ready to go.

Key steps:

• Choose your business name

• Register for self-assessment

• Find out what records to keep

• Understand how business expenses work

• Get to grips with tax and when it’s paid

• Budget for payments on account

• Register for VAT if applicable

• Open a business bank account

• Get insurance
  

What is a sole trader? 

A sole trader is a type of business structure where you independently own and run a business. You can still hire staff, but you are the sole owner of the business.

This means you are personally responsible for any business debts and liabilities because there is no legal distinction between you and the business.

Setting up as a sole trader

If you choose to set up as a sole trader, it’s important to follow the steps below:

1. Choose a business name

First of all, choose a suitable business name. This might be your own name, or you might want to be more creative and choose something that explains what your company does. 

Whatever name you pick, you must follow certain rules. For instance, sole traders must not include ‘limited (Ltd)’ or ‘limited liability partnership (LLP)’ or public limited company (PLC)’ in their name. In addition, your business name must not contain offensive language or suggest a connection with government or local authorities, unless you have permission to do so.

You should include your business name on all official documents, such as invoices. 

2. Register for self-assessment

Once you’ve chosen your business name, you can register as self-employed with HMRC. If you earned more than £1,000 before tax relief in the previous tax year, you need to register for self-assessment at the same time so you can pay your taxes.

Registering involves creating a Government Gateway account online, filling in the form, and providing personal information and details about your business. Once you’ve done this, HMRC sends your Unique Taxpayer Reference (UTR) in the post, which you need when you file your self-assessment tax return each year.

If you employ staff, you also need to register as an employer. 

3. Find out what records to keep

As a sole trader, it’s crucial to keep accurate financial records of all the money coming in and going out of your business. This includes proof of business sales and income, all allowable expenses, personal income, as well as VAT and pay-as-you-earn (PAYE) records, if applicable.

Maintaining accurate records helps considerably when it comes to filing your tax return, and you’ll have them ready if HMRC ever asks to see them. You need to keep these records for at least five years after the submission deadline of the relevant tax year.

If you don’t want the hassle of completing your bookkeeping manually, accounting software can make the process much easier. 

4. Understand business expenses

If you buy items that support the operation of your business, you might be able to claim them as allowable business expenses. This means you can deduct their value from your business income to reduce the amount of taxable profit. 

As an example, if your income was £40,000 and you claimed £5,000 in allowable expenses, you’d only pay tax on the remaining £35,000.

You can only claim for business-related expenses, although if you use something for both personal and business reasons, you can usually claim a proportion of these costs. This might include your heating and electricity costs if you work from home, for instance. 

There’s a comprehensive list of allowable expenses on the gov.uk website. The most common examples are office costs (such as stationery), travel costs (such as fuel and train fares), advertising and marketing costs, and insurance and bank charges. 

5. Get to grips with tax

As a sole trader, you need to pay tax on the income you earn, once you’ve deducted your allowable expenses. This works differently to the PAYE scheme used for company employees, where your tax is automatically deducted from your pay each month. 

You must also pay Class 4 National Insurance if your profits are over £12,570. Sole traders no longer need to pay Class 2 National Insurance, although you can make voluntary contributions if you have profits of less than £6,725. If your profits are £6,725 or more, your Class 2 contributions are treated as having been paid to protect your National Insurance record and, therefore, your state pension. 

Currently, sole traders only need to file their self-assessment tax return once a year. If you’re filing on paper, the deadline is 31 October for the previous tax year. If you’re filing online, you have until 31 January to file. This is also the deadline for paying any tax due. Late payments can result in hefty financial penalties. 

From April 2026, sole traders with an income of more than £50,000 a year must start keeping digital records of accounts and send summaries every quarter rather than file a tax return each year. This rule will apply to those earning between £30,000 and £50,000 from April 2027.

6. Budget for payments on account

If the income tax due in your first year of trading is more than £1,000, you also need to make payments on account. These are payments towards your next year’s income tax bill and are made twice a year, so it’s important to budget for them.

The amount you pay each time is half of your previous year’s tax bill. The first payment is due by 31 January and the second by 31 July. 

Payments on account can be a shock the first time you encounter them if you’re not prepared. This is because your first payment is due the same day you pay off your bill for the previous tax year.  

Example Imagine you started trading in 2023/24 and had a tax bill of £5,000 for that tax year. This amount would be due for payment on 31 January 2025. 

However, you also have to make your first payment on account by the same date. 

This means you would have to pay a further £2,500 (half of £5,000) towards your 2024/25 tax bill on 31 January 2025, taking your total payment by that date to £7,500. 

The second payment on account, which would also be £2,500, would be due by 31 July 2025. 

If you end up paying too much tax because your tax 2024/25 bill ends up being lower, HMRC refunds you the difference. 

7. Check if you need to register for VAT

If you earn more than £90,000 in any 12-month period, or your taxable turnover is likely to exceed this limit in the next 30 days, you must register for VAT. You can also register voluntarily. 

This means you must file a VAT return every quarter. You must charge your customers VAT and pay the VAT you’ve collected to HMRC, but you can also claim back any VAT you’ve paid as an expense.

8. Consider a business bank account

Unlike limited companies, sole traders don’t legally need to have a business bank account – but it can still be beneficial to open one. 

The key reason for opening a business bank account is that it keeps your business finances separate from your personal money. This makes filing your tax return less complicated, as it’s easy to tell which expenses relate to your business.  

But there are other perks to opening a business account. For example, you might be able to use invoicing tools that send and chase invoices on your behalf. You might also have access to accounting software which can make it easier to juggle your finances. Some accounts include savings pots where you can set aside money for tax payments and other expenses.

Always be mindful monthly fees and transaction charges when choosing an account, and be sure to choose one that aligns with your business needs.

9. Check what insurance you need

Finally, you need to work out what type of business insurance you need as a sole trader. This depends on the type and size of the business you run.

• Employers’ liability insurance is a legal requirement if you employ one or more employees. This can cover the cost of compensation claims if a member of staff becomes ill or is injured due to the work they do for you.

• Public liability insurance protects you against legal costs if a member of the public, customer, or client sues you because of an injury or damage to their property caused by your business activities. This could be valuable if clients or customers regularly visit your premises, you work in people’s homes, businesses, or in public. 

• Professional indemnity insurance protects you if a client makes a claim against you for negligence, errors, or omissions in your work that cause them to lose money.

• Income protection insurance could prove valuable if you cannot work due to illness or injury as it pays out a regular income to replace your lost earnings.