January 26, 2022If you’ve recently made the switch from full-time employee to self-employed sole trader, you might have some questions surrounding your newfound responsibilities as a business owner.
Of these responsibilities is filing a Self Assessment tax return, a crucial piece of paperwork filed by sole traders on a yearly basis to HM Revenue and Customs (HMRC). This form details the sole traders income and business expenses, and in return HMRC calculates how much Income Tax is owed based on the sole trader’s taxable profits.
But what is Income Tax? In this guide, we’ll be taking a deep dive into everything you need to know about Income Tax, including what it is, how to calculate it and how to pay your tax bill.
What is Income Tax?
Simply put, Income Tax is a tax on any income you’ve made in the previous tax year. This is typically taken from your wages or earnings from work, but can also come from interest and dividends from savings and investments, some state benefits, and rental earnings (if you’re a landlord).However, your total income in a tax year isn’t necessarily your taxable income. There are several factors involved that influence the final figure on your tax bill, from the tax bracket you fall into, to the total amount of tax you can claim back through allowable expenses.
As mentioned above, Income Tax is, for most workers, deducted at source from their wages or salary through PAYE.
Whenever a company runs payroll, the total amount of Income Tax and National Insurance contributions (NICs) owed is set aside, with a full breakdown of the total tax paid by the employee visible on their payslip. The remaining amount is given to the employee as their take-home amount.
For limited company directors and self-employed sole traders, however, Income Tax can be calculated and paid by submitting a Self Assessment tax return. Failure to register for Self Assessment can see you faced with some hefty penalties from HMRC, so it’s a good rule of thumb to get registered within three months of setting up your business.Once registered, HMRC will send you a Unique Taxpayer Reference (UTR) number that you’ll need to have close to hand when submitting your Self Assessment.
How much Income Tax do I need to pay?
As a rule of thumb, the total amount of Income Tax owed is determined by your total taxable profit, which can be worked out using the following equation:
Once you’ve determined how much your taxable profit is, you’ll then be placed in a certain tax band, which will then determine the total amount of Income Tax you owe.
Tax bands
There are two factors that influence the tax band that you, as a Self Assessment taxpayer, fall into: your taxable profit and where you live in the United Kingdom.If you live in England, Wales or Northern Ireland, you can either be classed as a basic rate taxpayer, higher rate taxpayer or an additional rate taxpayer. For those in Scotland, the Income Tax rates are starter, basic, intermediate, higher or top rate.
England, Wales and Northern Ireland 2021/22 tax bands
Scotland 2021/22 tax bands
For the tax year 2021/22, it’s worth noting that the first £12,570 earned isn’t taxed. This is because this is what’s classified as your Personal Allowance, which is the total amount of tax-free personal income you can get in a tax year.This amount is the same for the majority of UK taxpayers, yet only is applicable to those with a taxable income below £100,000. After surpassing this threshold, the Personal Allowance for these high earners decreased by £1 for every £2 of income above the limit, eventually decreasing to zero if your income is high enough.
How can I reduce my Income Tax bill?
As noted by the equation above, your taxable profit can be influenced by the total amount accrued in business expenses.These are expenses that have been made solely for business purposes, and depending on the type of purchase, you can find yourself saving a significant sum on your tax bill when claiming these tax reliefs.Here are just a few different types of tax reliefs you can claim back on your tax return:
Before you start listing every business expense you’ve accrued across the year on your Self Assessment, keep in mind that you’ll need to keep records of your expenditure to support what you’ve written on your tax return. Not only is this a legal obligation, but HMRC can request to see receipts and invoices at any point within five years after your submission, so it’s good to get into the habit of holding onto your receipts.
With Ember, our instant snap-and-store receipt capture feature means your receipts and invoices can be safely stored in one place, meaning the information you need to file your Self Assessment is both easily accessible and readily available. We’ll also automatically the source tax breaks you’re entitled to, ensuring you never have to pay more than you have to, all the while keeping you in HMRC’s good books.
