"Self-employed" is a broad term for anyone working for themselves (not an employee), while a "sole trader" (or sole proprietor) is a specific legal structure where one person owns and runs a business alone, meaning the owner and business are legally the same entity, responsible for all profits and debts. So, all sole traders are self-employed, but not all self-employed individuals are sole traders; a self-employed person could also be in a partnership or a limited company.
Sole Traders take on all the risks of starting their own business themselves including in some cases unlimited liability. Start-up costs, although limited help is available, Sole Traders are mainly responsible for all their own business costs.
The field of self-employment can include doctors, lawyers, accountants, hairstylists, and freelancers. It may also include those who are independent contractors. Every sole proprietor is also considered to be self-employed, although someone who is self-employed might not be a sole proprietor.
Limited liability company (LLC)
Profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.
Extra Taxes
Every LLC registered to do business in California, and LLCs that have elected to be taxed as a corporation must pay an $800 annual tax. This is the highest minimum LLC tax in the United States. This annual tax isn't imposed on sole proprietors.
As a self-employed individual, you pay both income tax and a 15.3% self-employment tax (Social Security & Medicare) on 92.35% of your net earnings (profit after business deductions), plus potential state income tax, requiring quarterly estimated tax payments to the IRS to avoid penalties, often setting aside 25-30% of income for taxes.
For sole proprietors and other pass-through businesses, 2025's tax-free threshold is $15,000 for single filers and $30,000 for married couples filing jointly. C corporations will pay a flat tax rate of 21% for 2025. Small business owners with net income of $400 or more must pay self-employment tax.
Self-employment means you're in business for yourself, not an employee, working as a sole proprietor, independent contractor, freelancer, or partner, controlling your work hours, paying your own taxes (like self-employment tax for Social Security/Medicare), and taking on profit/loss risk, encompassing various gigs from ride-sharing to running a full business.
A business bank account is not legally required for sole proprietors, but it is highly recommended for effective financial management and IRS compliance. Having a separate account helps in organizing expenses, establishing business credibility, and simplifying tax filing.
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.
Here are a few mistakes small business owners should avoid:
Expenses that you can claim as a Sole Trader
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 Proprietorships
This structure is known for being simple to set up for most small business owners. Once you're registered and licensed with your state and local governments, you're ready to go.
20 Tax Deductions for Self-Employed People
As a sole proprietor, you may be able to write off health insurance premiums, business expenses like equipment and travel, and even part of your self-employment taxes. Discover essential tips for sole proprietors and ensure you're taking full advantage of available deductions to maximize your tax savings.
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).
Forgetting to Set Aside Money for Taxes
One of the most common pitfalls for the self-employed is not reserving enough funds to cover their tax liabilities. Unlike traditional employment, taxes aren't automatically withheld for you. Failing to save for taxes can lead to financial strain when payment becomes due.
How much tax does a sole trader pay? A sole trader pays tax on their total taxable income at the individual income tax rates. The tax percentage varies based on income levels, from 0% on income up to $18,200 to 45% on income over $190,001, plus the 2% Medicare levy.