Discover seven essential aspects of transitioning to self-employment
Learn about the distinctions between a sole trader and a limited company, as well as how to manage your taxes when establishing your own self-employed venture in this article.
1. Sole trader vs limited company
2. Register your business with HMRC
3. Consider your self-assessment income tax
4. Do you need to register for VAT?
5. Traditional accounting vs cash basis
6. What kind of insurance do you need?
7. Do you need a business bank account?
Starting your own business may appear overwhelming, as it involves numerous uncertainties.
Deciding between being a sole trader or establishing a limited company, informing the necessary parties, and understanding the tax implications are all crucial considerations to address before diving in.
Here are nine key aspects to ponder on before embarking on this journey.
1. Sole trader vs limited company
Firstly, you must determine the type of structure you desire for your business. The majority of self-employed trade businesses typically choose between operating as a sole trader or a private limited company.
What is a sole trader?
Sole traders operate with the most straightforward structure, where they manage their own business and retain any profits remaining after taxes. They are also accountable for any debts accumulated by the business. This type of business setup is suitable for individuals who work independently.
Although identified as a business, sole traders are not required to have business premises or a distinct business name from their own - it simply denotes an individual working independently.
What is a private limited company?
If you want your business to be a distinct legal entity from yourself, setting it up as a private limited company may be the most suitable option, even though it involves a more complex setup process.
To begin with, limited companies need to be registered with Companies House, where a director - typically the business founder - and at least one shareholder must be appointed. The company will be liable for corporation tax on its profits, and the remaining funds will be distributed among the shareholders.
As the director, you will be required to file an annual company tax return with HMRC, along with a self-assessment tax return that outlines your personal income.
Limited partnerships
This business option is not as common and is ideal for individuals starting a business with one or more partners. Each partner in the business is accountable for any debts incurred, and they must all file a self-assessment tax return to report their personal income from the business.
Additionally, someone will also be required to file a tax return for the business entity.
Limited liability partnerships
This choice falls midway between a partnership and a limited company. Similar to a partnership, it can be established by two or more individuals, but it must also be registered with Companies House and operate as a distinct legal entity from its owners.
2. Register your business with HMRC
Once you have chosen the type of business you are establishing, you must inform the tax authority of its existence.
For sole traders, it is necessary to apply for a National Insurance number (if you do not already have one) and register for self-assessment by 5 October before your first tax return is due.
Therefore, if you establish your business in September 2020, you must ensure that you are registered for self-assessment by 5 October 2021, since your first tax return for the 2020-21 tax year will not be due until January 2022.
If you opt for a limited company, you will need to register an official company address and select a 'SIC code' to indicate the nature of your business - you can search for them online.
You will also need to register your business with Companies House, as well as for corporation tax.
Learn more in our guide to corporation tax
3. Consider your self-assessment income tax
It is important to note that the type of business you establish will impact your personal tax responsibilities in various ways. However, regardless of your choice, you will need to complete a self-assessment tax return.
This return must be submitted annually; if you opt for a paper submission, it must reach HMRC by 31 October, whereas online submissions should be received by 31 January.
Failure to submit your tax return on time can result in significant penalties - refer to our article on late tax returns and penalties for mistakes for further information.
4. Do you need to register for VAT?
If your business’ VAT taxable turnover exceeds £85,000, you are required to register for VAT. This turnover encompasses the total value of all non-exempt sales.
If your turnover falls below this threshold, VAT registration is not mandatory. However, it could be advantageous if you regularly incur VAT expenses on business purchases like laptops, tools, and stationery.
Upon VAT registration, you become eligible to reclaim the VAT paid.
An important consideration of voluntary VAT registration is the obligation to charge VAT on your goods and services, and to submit a VAT return to HMRC every quarter.
For further details, refer to our guide on self-employed VAT returns.
5. Traditional accounting vs cash basis
Deciding on how to handle the funds generated by your business is crucial as it impacts your tax filing. Most self-employed individuals typically choose the cash basis method, which is recommended for those with an annual turnover below £150,000 operating as a sole trader or in a partnership.
The cash basis approach involves paying tax and deducting expenses according to when the funds are received in your account. For example, if you invoice a client in February 2020 but receive the payment in mid-April, you only consider the receipt date for tax purposes.
Under this method, income is reported in the tax return for the year in which it is received, rather than when the work was initially agreed upon. In contrast, traditional accounting requires reporting income and expenses based on the invoice date, regardless of when the payment is actually received.
6. What kind of insurance do you need?
Regardless of the size of your business, whether you operate as a sole trader or have multiple employees in a limited company, it is crucial to have the appropriate insurance coverage to safeguard your business in case of any unforeseen circumstances.
Public liability insurance is a key type of insurance that traders should have, as it protects against legal expenses and compensation in the event of injury or damage resulting from a lawsuit by a member of the public. This insurance is also essential for accreditation by reputable programs such as Which? Trusted Traders.
If you have business premises, it is important to insure both the premises and their contents. Additionally, professional indemnity insurance can cover costs in case a customer raises concerns about your services.
For more information, refer to our guide on public liability insurance.
7. Do you need a business bank account?
If you are a sole trader or in a partnership, having a business bank account is not mandatory, but it can be beneficial, it is essential however to have one if you are operating a limited company.
By having a business bank account, you can effectively separate your business finances from personal expenses, simplifying the process of reporting your income to HMRC.
While some accounts may come with a monthly fee, it is important to select one that provides services that best suit your needs.
Major UK banks offer various business bank account options, and challenger banks like Starling offer app-only alternatives, which can be convenient for those who are comfortable without branch access.
We understand that managing a business in the digital era can be both challenging and rewarding, and we acknowledge that traditional financial institutions may not always keep pace.
Monzo is not your typical business account. If you are looking to streamline your regular financial tasks, reclaim time for planning your next moves, and grow rapidly, you are in the right place.
Joining us is straightforward. If you are curious about the process, we will assist you through a typical sign-up journey. This helpful guide will lead you through the initial steps.
How do I open a Monzo Business account?
To begin, you can click the image above after that, you will be guided to complete a short online application form. Initially, we will request some standard personal information such as your full name, address, and date of birth.
Subsequently, we will inquire about your business by requesting fundamental incorporation details.
These details will include your company's registered name, incorporation number, and trading name. In case we are unable to locate your company using this information, we may request your most recent incorporation certificate or registry extract.
It then takes about a week to tn days for your acrd to arrive, once arrived you simply register it via the app and your ready to go.
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