As a sole trader, a general rule is to set aside 25-35% of your net income (profit after expenses) for taxes. This covers federal, state, and self-employment taxes (15.3% for Social Security and Medicare). It is highly recommended to overestimate to avoid shortfalls, often by saving 25% to 30%.
You pay £5,486 (20%) on your salary between £12,570 and £40,000. You pay no NI contributions on the first £12,570 that you make. That's not all. Your employer is also required to pay separate NI contributions, but these won't come out of your wages.
There are five potential disadvantages that come with being a sole trader:
If your business entity is a sole proprietorship, or you have a net profit reported on your individual income tax return from a partnership or S corporation, you pay any California or federal income tax liability by making quarterly estimated tax payments.
Yes, if you have net earnings of $400 or more from self-employment, you must file a federal tax return to pay self-employment tax (Social Security and Medicare), even if your total income is less than $5,000. You'd file a return (Form 1040) to report this income and pay the tax via Schedule SE and likely estimated quarterly taxes, but you still need to file if your other income (like W-2 wages) meets other standard IRS filing thresholds (e.g., $14,600 for single filers in 2025).
The biggest risk of becoming a sole trader is unlimited liability. If your business incurs debt or legal issues, your personal assets such as your home, savings or car may be used to cover obligations. This is in contrast with a company structure, where a shareholder's liability is usually limited.
Sole trader businesses have 'unlimited liability' which means owners are personally responsible for all of the debts of the business. If something goes wrong, you will have less protection.
Sole trading is a way to run a business. A sole trader is a self-employed individual who is the exclusive owner of their business. Sole trader businesses do not need to register with Companies House. Because sole traders are self-employed, they must pay tax through self-assessment.
The self-employed may pay more taxes than what an employer pays in FICA per employee. The reason is that self-employed individuals pay both the employer and employee portion of FICA tax. However, there are deductions that can help eligible self-employed people reduce their federal and state tax liabilities.
Unemployment compensation generally is taxable. Inheritances, gifts, cash rebates, alimony payments (for divorce decrees finalized after 2018), child support payments, most healthcare benefits, welfare payments, and money that is reimbursed from qualifying adoptions are deemed nontaxable by the IRS.
Here are a few mistakes small business owners should avoid:
Business expenses you can report if you're self-employed
To avoid the 22% tax bracket (or any higher bracket), focus on reducing your taxable income through strategies like maxing out 401(k)s and HSAs, deferring bonuses, tax-loss harvesting, smart charitable giving, and strategic asset location, understanding that higher rates only apply to income within that bracket, not your entire income.
If you're a sole trader wondering what business expenses can be claimed, while not exhaustive, this list provides a useful starting point.
Disadvantages of being a sole trader
5 Ways to protect yourself from small business litigation
Sole traders must file their self-assessment tax returns accurately and on time. Failure to do so may lead to an investigation by HMRC. While audits are uncommon for sole traders, they can occur under certain circumstances, such as discrepancies in reported income or random checks conducted by HMRC.
Sole proprietorships often have limited access to capital, which can hinder their growth and ability to survive in competitive markets. Having a solid financial plan and exploring alternative funding sources can help overcome this challenge.
To file your annual income tax return, you will need to use Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), to report any income or loss from a business you operated or profession you practiced as a sole proprietor, or gig work performed.
How to Keep More of Your Money (and Pay Less Taxes)