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If you’re already a sole trader, or just thinking of starting out as one, it’s important to have a firm idea of the tax that you’re required to pay on your self-employed income. After all, as is the case for all 4.5m people working for themselves in the UK, it will be your responsibility to submit and pay accurate tax returns on time. In this simple guide to sole trader tax, we’ll look at the types and amount of tax a sole trader is likely to pay, how much you should be setting aside, the best way to compliantly reduce your tax liabilities and much more.
How much tax you will pay depends on the amount of profit you make, and how much income you earn in a financial year, which starts on 6th April and ends twelve months later on the 5th April. Profit is subject to tax once your income exceeds the tax-free personal allowance threshold, which for the 2022/23 tax year is £12,570 and will remain so until 2026.
You’ll be glad to hear that tax is less complicated for sole traders compared to those who work through their own limited company. We’ll now look at the types of sole trader tax and their rates:
Income Tax is paid on income you receive personally, whether that’s profit you’ve earned from your business, rental income from a property, money made from investments, by working as an employee or any dividends drawn from a company, for example. You’ll need to calculate all of this, minus any legitimate business expenses, before filing a tax return and paying the associated tax due to HMRC by 31st January every year.
In most cases, sole traders must also make payments on account (POA) towards the following tax year. Payments on account are advance payments towards the following year’s tax bill and will be based on you earning the same level of income/profit next year as you did this one.
The advance payments are split into two equal payments, with the 1st POA due on the 31st January and the 2nd POA by 31 July.
If, when your tax return is calculated for that year, your payments on account were less than the tax due, you will make a balancing payment, and if you overpaid, you should receive a refund from the HMRC.
This is the HMRC’s way of helping you spread out your tax payments and to collect money faster. The only instances in which you won’t need to make a payment on account is if your last Self-Assessment tax bill was under £1,000 or if you’ve already paid over 80% of all the tax you owe.
Here are the Income Tax bands and rates for England and Wales for the 2022/23 tax year:
|Tax band||Taxable income||Tax rate|
|Personal allowance||Up to £12,570||0%|
|Basic rate||£12,501 to £50,270||20%|
|Higher rate||£50,271 to £150,000||40%|
|Additional rate||Over £150,000||45%|
If you live in Scotland, Income Tax is slightly different. You’ll find more information about Scottish Income Tax on the government website.
National Insurance Contributions (NICs) are payments made by self-employed workers and employees that help fund public services, like the NHS and various government departments. They also help people build up an entitlement to receive certain benefits, like the state pension. If you’re a sole trader without any employees, there are two types of NICs to take into account. The following need to be paid as part of your Self-Assessment Tax Return or payment on account:
If your profit exceeds £6,725 (above the ‘Small Profits Threshold’ for 2022/23), you’ll need to pay the equivalent of £3.15 a week (£163.80 per year) in Class 2 NICs.
If you record a profit of over £9,880 in 2022/23 you’ll need to pay 10.25% Class 4 NICs on any profit up to £50,270, and a further 3.25% on profit achieved over this.
VAT is added to the cost of most things we all buy in the UK. As a sole trader, if your annual turnover exceeds £85,000 within a 12 month period or you expect it to within a 30 day period, you’re required to register for VAT and start charging it to your clients, but you can choose to voluntarily register whenever you wish, as there are some gains to be made from being VAT registered
If and when this applies to your business, you’ll need to prepare, submit and pay quarterly VAT returns to HMRC. Don’t worry though, the idea is that the amount of VAT you pay, has been charged to and received from your clients (20% for most businesses) and so in theory, being VAT shouldn’t mean you lose out, especially as you will be eligible to reclaim VAT charged on any of your expenditure.
Sole trader tax is based on the profit made by your business. It, therefore, goes without saying that understanding what profit is and how it’s calculated is really important.
Profit is the money left over after all business expenses have been taken into account. Let’s say you turnover £40,000 in a tax year and your business expenses amount to £10,000 - your profit is £30,000, which is the amount you’ll pay tax on. Obviously, it’s unlikely to be this straightforward in reality, but hopefully, you get the gist.
Expenses are costs incurred when running your business. As highlighted in the above scenario, they offset the amount of tax you pay as a sole trader. These expenses could be accounting fees, pension contributions, office rent or technology, and software bought so you can carry out your work. While some expenses have what HMRC classes as a ‘dual purpose’, the majority can only be claimed if they are incurred ‘wholly and exclusively' for your business.
Firstly, be very cautious of any complex schemes that claim to reduce your tax liability or promise that you’ll pay very little or next to no tax at all. The likelihood is that they’re non-compliant, meaning they should be avoided at all costs. The safest way to legally minimise the amount of tax you pay is by claiming back every legitimate expense incurred when running your business.
When it comes to putting money aside for your sole trader tax bill, it’s usually best to overestimate. You don’t want to find yourself short when the Self-Assessment Tax Return deadline rolls around. To work out how much to put aside for tax, you’ll need to keep a close eye on your profits. Saving 5% on top of your expected tax rate (whether 20%, 40% or 45%) is a sensible thing to do. For example, if your annual profit is likely to fall under £50,000, put aside 25% of this every month just to make sure you’re covered. If you’re not sure how much profit you’ve made or need some expert advice, feel free to contact SJD Accountancy, to speak to an expert.
Aside from VAT, which is submitted and paid quarterly, sole traders pay tax via the Self-Assessment Tax Return every January.
Most sole traders find that opening a separate bank account makes keeping track of income and expenses, and in turn, working out how much tax they owe, a lot easier. With regards to paying yourself, as a sole trader, you’re free to use the money you’ve earned as and when you like. After all, it’s yours and not the companies. That said, keeping to a set amount each month will help with budgeting. You also need to make sure you have enough left over for tax, while building up a rainy day fund is generally seen as a smart thing to do.
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Appointing an accountant can save you time and stress when starting up on your own. If you would like to speak to someone about any of the above information or any other queries you may have, arrange a callback and a member of the team will be in touch.