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A Complete Guide to Sole Trader Tax

November 23, 2021

If you're making the switch to self-employment, you may have been drawn to the freedom that comes with being your own boss. However, as the captain of your own ship, you're now responsible for handling the business admin your bosses would have taken care of on your behalf — including doing your business taxes.

The types of business tax you pay are determined by the business structure you choose, with the sole trader model being the simplest option. Despite its simplicity, there are still a fair few rules to wrap your head around when it comes to keeping on top of your taxes.

In this article, we'll be giving a brief overview of the different taxes that sole traders need to pay, when they need to pay by and how to get your taxes submitted on time.

How do I pay tax as a sole trader?

If you worked for a different company before starting up your own, your taxes would have been paid through PAYE (Pay As You Earn) by your employer. These taxes would be deducted from your monthly earnings and sent to HMRC on your behalf, with the remaining sum being your take-home amount.

Sole traders, on the other hand, must submit a Self Assessment tax return by 31st January every year, detailing their gross earnings, their taxable profit and their business expenses for the year. The details submitted through the Self Assessment determine the taxes that need to be paid to HMRC by the 31st Jan the following year.

Registering for Self Assessment

If you've only just embarked on your solo career, you don't need to panic about signing up for a Self Assessment from day one. You will, however, need to register if you fall under one of the following categories:

  • You have earned more than £1000 from self-employment in a tax year
  • You need to prove you're self-employed, for example to claim tax-free childcare
  • You want to make voluntary Class 2 National Insurance contributions to help you qualify for state benefits

If you tick any of the above boxes, be sure to register for Self Assessment no later than 5th October after the end of the tax year you're looking to file for.

Once you've set up your Government Gateway account, expect to receive a letter from HMRC with your Unique Taxpayer Reference (UTR) and an activation code within a two week timeframe, allowing you to activate your online account. For a more detailed overview on registering for Self Assessment, check out our article .From there, you can fill in your details and file your Self Assessment tax return (otherwise known as a SA100) — or, if you're not feeling up to the paperwork, you can let us file it for you.

What taxes do I need to pay as a sole trader?

In most cases, sole traders will only need to pay Class 2 and Class 4 National Insurance contributions (NICs) and Income Tax to HMRC. A handful may need to pay Value Added TAX (VAT), but only those earning above £85,000 a year, or those who opt in to do so.

Once you've submitted your Self Assessment tax return, HMRC will send you your Self Assessment tax bill, which will be the sum of your National Insurance contributions and Income Tax. The deadlines for paying your tax bill fall on 31st January for any outstanding tax from the previous tax year (known as a balancing payment) and the first instalment of your payment on account, and 31st July for the second and final payment on account instalment.

Income Tax

Income Tax is a tax on the income you've made from self-employment minus any business expenses you've accrued. This is otherwise known as a taxable profit, and can be summarised as follows:

Taxable profit = Total profit - Business expenses

Since your taxes are no longer being deducted at source (i.e. your tax isn't taken from a monthly salary) — unless you are a part of the Construction Industry Scheme (CIS) —  it's important to make sure you've set enough aside for when it's time to submit your Self Assessment.

To makes sure your tax bill is accurate when it comes to submitting your Self Assessment, it's important to keep detailed records of your expenditure. Not only will them reduce the likelihood of overpaying your taxes, but by keeping track of your business expenses can allow you to claim for certain tax reliefs aimed at small businesses, such as allowable expenses and capital allowances.

To avoid falling short at the deadline, it's good to get a rough understanding of how much you'll be asked to pay. For this to happen, you'll first need to have a solid understanding of tax bands.

Tax bands

Unless you're earning over £100,000 a year, it's likely you'll have a Personal Allowance of £12,570, meaning you won't have to pay Income Tax on the first £12k you earn. Once you've exceeded this, you'll fall into one of the following tax bands depending on your income:

Band Personal Allowance Tax Rate
Personal Allowance Up to £12,570 0%
Basic rate £12,571 to £50,270 20%
Higher rate £50,271 to £150,000 40%
Additional rate Over £150,000 45%
The bands can be adjusted through pension contributions and donations (which you can find out all about in our article 'Tax saving tips for sole traders), alongside other tax-free allowances that, with the help of an Ember accountant, can be worked out for you.

National Insurance

Income Tax isn't the only tax affected by the total amount you earn — your profits can also affect how much you pay in National Insurance.

Class 2 National Insurance is determined by the Small Profits Threshold, where if you surpass the threshold you can expect to pay a weekly rate in National Insurance. For the tax year 2021/22, the threshold is £6,515 with a rate of £3.05 a week, amounting to £158.60 in tax.

If your profit falls below £9,568, you won't be charged Class 4 National Insurance. However, once you're earning above that amount, you'll then be taxed on a percentage basis.

For those earning between £9,568 and £50,270, you''ll be taxed at 9% of your profits in the tax year 2021/2022. If you earn more than £50,270, you'll be charged 2%.

Class 2 and Class 4 National Insurance contributions will not be impacted by other taxable income, meaning that the figures you get from your Personal Tax report will be accurate.

Payments on accounts

If you're new to starting a business, you'll want to make sure that you've got enough set aside to pay your tax bill for both this year and the next. This might seem like quite a tall order for businesses who've barely started making revenue, but with payments on account giving many a new business owner a nasty shock, it's good to be prepared.

Payments on account are advanced payments towards the following year's tax bill, which HMRC estimates to be the same as the bill for the present tax year. Each payment is half of your previous year's tax bill and is paid in two instalments — the first on the 31st January and the second on the 31st July — unless:

  • Your last Self Assessment tax bill was less than £1,000
  • You've already paid more than 80% of the tax you owe, for example through your tax code or through the bank deducting interest on savings

Since the figure for your payments on account submission is an estimate, you might find yourself overpaying or underpaying in tax. If you overpay, HMRC will refund you the difference, whereas underpayment means you'll be charged interest. You can, however, make a balancing payment prior the 31st January the following year to settle the bill.

The caveat for new business owners in their first year of trading lies in the expectation to pay their tax bill for the past year and 50% of their tax bill for the next. Without being aware of needing to set aside for payments on account, many new business owners often fall short of having the cash they need readily available, leading to problems with cash flow and potential fines.

With Ember's personal tax report, we'll estimate how much tax you owe to help you avoid any late filings, and our dedicated accountants are always on hand to help with any tricky tax queries.

Making Tax Digital (MTD)

To make these payments more manageable for small business owners, the government plans to introduce Making Tax Digital for Income Tax Self Assessment (ITSA) from 6th April 2024.

MTD was established by the government to simplify the way business owners submit their taxes, reducing the risk of being fined for missed deadlines and underpaid taxes. Having MTD-ready software (such as Ember) on hand can also help you keep your digital records organised, making them easier to maintain and review.

Summary

Wrapping your head around sole trader tax is never easy, but getting to grips with the fundamentals is the key to maintaining a positive cash flow and avoiding fines in the future. To recap:

  • If you've earned more than £1,000 in a tax year from self-employment, you'll need to sign up for Self Assessment.
  • Your Self Assessment tax bill covers your Income Tax from the current tax year and your Class 2 and Class 4 National Insurance contributions.
  • The total amount of Income Tax and Class 4 National Insurance owed is influenced by your taxable profit, whereas the amount of Class 2 National Insurance owed is set at a fixed rate by HMRC.
  • The deadline for submitting your Self Assessment is the 31st January.
  • The 31st January also marks the deadline for your first payments on account instalment, which covers the first half of your tax bill for the following tax year. The second instalment is due on the 31st July.
  • If you're earning about £85,000 in a tax year, you'll need to register for VAT.

To make sole trader tax less taxing, we've made it possible to automate your taxes all the while finding the best ways to cut down your tax bill. Focus on running your business — we'll take care of the rest.

Join us in creating the new age of accounting.

Simple language, simple software, so that you can spend less time dealing with admin and more time focusing on what really matters.

Rachel Cameron-Potter

Rachel is a Content Marketer at Ember with a love of writing, editing and all things creative. After graduating from York with a degree in English, Rachel has dabbled extensively in content creation, working as a fundraising lead for a letterpress studio, a digital marketer on a political campaign, a magazine editor, voice over artist and freelance writer.