Taxes to Pay as a Sole Trader

In this guide, we look at the taxes you will encounter if you start your own business as a sole trader.

Before you start up in business, one of the first decisions you need to make is which business structure to work under.   The most popular options are to set up your own limited company or to work as a sole traderand both have pros and cons. It is an important decision, and one that is influenced by your personal situation and long-term plans for your business.

To know more about Sole Trader and Limited Company businesses, please read  “What is a Sole Trader” and  “What is a Limited Liability Company”

Self Assessment Tax Return

ASelf Assessment has to be completed by the 31st January each year. This involves completing a Self Assessment (or Form SA100) and is usually done online, though it’s still possible to file in the old fashioned way with a paper form.

Self Assessment is HMRC’s way of finding out how much Income Tax and National Insurance you need to pay. Employees have their Income Tax deducted automatically from their employment income through the PAYE system – this doesn’t happen for self-employed workers, or for some other types of income, such as dividends, pensions or income from savings and investments, which is where the Self Assessment comes in.

If you decide to start working for yourself, you must inform HMRC of your decision, regardless of wether you already complete a Self Assesssment tax return.

It is best to register with HMRC as soon as you start trading. The latest  you can register is by the 5^th October in your business’ second tax year.    HMRC can issue penalties for late registration, so it’s in your best interests to do this on time.

Once you are registered as self-employed, you should automatically be sent a Self  Assessment notice following the end of each tax year.

The days of submitting a paper tax return are almost behind us, with HMRC encouraging all taxpayers to submit their self assessment returns online these days.

What is UTR number?

A Unique Tax Reference (UTR) is a reference number assigned by HMRC to identify you as a tax payer.  You should quote this number whenever you correspond with HMRC.  If you register as self-employed or a sole trader, HMRC will issue your UTR automatically, usually within 28 days.

How much income tax will I pay as a sole trader?

All the figures in the following example are based on the HMRC published rates and thresholds for the 2020/21 tax year.

Your Income Tax is always calculated on total earnings, so you’ll have to pay tax on amounts above the Personal Allowance for your combined income from employment and sole trader profits (from self-employment). We’ll talk about the difference between income and profits a bit later.

It’s important to realise that if your sole trader profits push your total earnings into a higher tax band, you’ll have to pay the higher rate.

An example for the 2020/21* tax year:

You’ll pay income tax of 20% on all earnings above your personal allowance and below the upper limit of the basic rate, which is £37,500 for the 2020/21 tax year. You’ll pay income tax of 40% on all earnings above the basic rate limit until you reach the higher rate limit (which in the 2020/21 tax year is £100,000). In this example, you pay 40% tax on the income of £5,000.

When you prepare your annual Self Assessment tax return, you will disclose the tax already paid on your earnings from your employer (in this example £35,000 would have been taxed under PAYE arrangements). So HMRC will know you have already paid tax on part of your total income. The amount of tax you pay on your profits from self-employment (£20,000 in this example) will be worked out by HMRC when you submit your Self Assessment.

Paying National Insurance as a Sole Trader

As a sole trader you pay two types of national insurance contribution (NIC).

Firstly, if your self-employed profits exceed £6,475, you’ll have to pay a flat rate of £3.05 per week. This is called Class 2 National Insurance.  You usually pay Class 1 National Insurance through PAYE via your employer, but Class 2 is paid directly to HMRC through a direct debit, which you can register for online at Gov.uk.

If you’re doing well, you may also have to pay Class 4 National Insurance. This is charged at 9% for all self-employed profits between £9,500 and £50,000, and at 2% for all profits greater than £50,000.

Just like your Income Tax, Class 4 National Insurance contributions will be worked out on your Self Assessment tax return.

Computation of NIC from the above income example:

If you are employed, like in our example above, you’ll have your Class 1 National Insurance to pay too, through  PAYE deductions made by your employer for your paid employment.

Self-employed National Insurance contributions

Please refer to the table below for the NIC for 2019-20 and 2020-21

Paying your Tax Bill

As a Sole Trader, your tax is due before the 31^st January, following the tax year end.  If your tax bill is over  £ 1,000, then you must make payments on account.  This means that HMRC will collect your tax plus the current year’s tax in two payments; one payment before 31^st January and the second before 31^st July.

Do I need to register for VAT?

You must register for VAT if your turnover exceeds £85,000 (2020/21) in any given twelve  months.

However, if your customers are also VAT registered it could be beneficial to register for VAT voluntarily before you reach this threshold.

What happens if I start employing someone?

If you take an employee, you will need to register as an employer with HMRC straight away and start running payroll.

At LibabunAccountancy, we can process Payroll for you and submit it to HMRC.

We will  also process and submit your Tax returns, NIC, PAYE, and VAT to HMRC.

To discuss this, please give us a call on +44 01234 712840.

Need help with your accountancy?Get an instant quote

Libabun Accountancyis part of Libabun Business Agency.  We help Small Businesses grow, automate and thrive. 

Please refer to our main website for more details.