When setting up a new business as a sole trader, there are a great many benefits to take note of. One of the most enticing aspects is the idea of being your own boss, and having total control over the finances of your business and its profits. However, while you have control over the profits, you also have the sole responsibility of managing and keeping on top of all the taxes you need to pay. In this blog article, we will explore some of the central taxes you need to worry about as a sole trader, why you need to pay them, and how much you could expect to pay.
How are Sole Traders set up?
To begin, we will quickly explain what a sole trader business is. A sole trader, also known as a sole proprietorship, is a standard company structure type that you can choose for your business. Sole traders are defined as being run by one person, meaning there is no legal distinction between the business and its owner. Sole traders are the favoured structure for many new or startup businesses, as they are straightforward to set up and easy to get going when compared to other business structures.
For more general information on Sole Traders, you can read our blog on how to set yourself up as a sole trader.
Your responsibilities as a Sole Trader
Once your sole trader business has been set up and is ready to start operating, you will need to be aware of the following responsibilities in terms of taxation:
- Sole Traders must keep complete, up-to-date records on all of the businesses expenses and sales.
- Every year, you will need to send a Self Assessment tax return to HM Revenue and Customs (HMRC) at the end of every tax year.
- You will need to pay Income Tax on all of your businesses profits.
- You will also need to pay National Insurance rates; either Class 2 or Class 4.
As well as the responsibilities above, you will need to fulfil the following if the scenarios described apply to you or your business:
- If your business is operating with a turnover of £85,000 or higher, you will need to apply for VAT (Value Added Tax). You can also apply for VAT if you feel your business would benefit from it, but it only becomes a requirement when your turnover reaches £85,000 or higher.
- If your sole trader business operates within the construction industry, you may also need to apply for the Construction Industry Scheme (CIS). Contractors must apply for the scheme; subcontractors don’t, but deductions will be taken from their payments at a higher rate if they choose not to.
What about Sole Trader corporation tax?
Corporation Tax is another very common tax that all Limited Companies pay. However, as a Sole Trader, this is not something that you need to worry about, as an equivalent tax is paid through the Self Assessment tax return instead. You will need to consider Corporation Tax if you plan on eventually registering as a limited company, however. For more information on the differences between a Limited Company and a Sole Trader, you can read our blog should I register my Business or remain a Sole Trader.
Keeping records as a Sole Trader
As a sole trader (and if you’re a partner in a business partnership), one of your primary financial responsibilities will be keeping up-to-date records of all of your expenses and income. As well as this, you will need to keep records of your personal income too. Keeping records is vital and will play a role in how you manage your taxes. When compared to the bookkeeping required of a Limited Company, a sole trader has much less to do; you will need to keep records of:
- All of your business invoices and receipts.
- All instances of monthly income and expenditure.
- Receipts of any work transactions.
- Receipts of bills (for example, an office rent).
- If you own an office or work remotely from home, you may even be able to claim these bills back as a business expense from the HMRC. You can learn more about claiming business expenses.
To effectively keep records as a sole trader, tools like spreadsheets and bookkeeping software such as Quickbooks are a great way to do so. Spreadsheets like Excel are helpful for those wishing to send and manage their own invoices, while software can help you to automate your processes, invoices, receipts and link to your bank account.
Sole Trader Self assessment tax return
Self Assessment is the primary system used by the HMRC to collect income tax from sole traders. To file a self assessment tax return, you must first register to use the Self Assessment Service. The income tax will be automatically deducted from pensions, savings and wages. However, when your business has other sources of income, it must be reported in a Self Assessment tax return. Examples of such income sources include:
- Payment received from renting out a property.
- Payment received from tips and commission.
- All revenue from savings, dividends and investments.
- Income from other countries.
Sending your tax return
When sending your tax return to the HMRC, you can either send it online or through a physical paper form. Using GOV.UK to send your tax return online can provide you with helpful information, such as allowing you to check your details, view any previous returns, and print out your tax calculations. To send your tax return as a paper form, download these forms.
You must send your completed self assessment tax return by the appropriate deadline. The HMRC must receive your tax return and any money you owe by this deadline; as an example, the last tax year started on the 6th April 2020 and finished on the 5th April 2021. Failing to pay your taxes by the outlined deadline will result in you having to pay a penalty, which you can learn more about here. The deadlines for the next financial year are as follows:
- Paper Tax Returns must be submitted by the 31st October 2021.
- Online Tax Returns must be submitted by the 31st January 2022.
- Owed taxes must also be paid by the 31st January 2022.
Sole Trader income tax
The amount of money you need to pay as a Sole Trader for income tax depends on a variety of different factors, including:
- How much of your business income is above your personal allowance.
- The amount of income that falls within each tax band.
As a sole trader, you will have what’s known as a personal allowance that resets at the beginning of each tax year. A personal allowance is the maximum amount of money that you can earn without paying taxes on it. Your personal allowance may change depending on the amount of money that you earn. For the 2021/22 financial year:
- The base amount of tax-free personal allowance is £12,500.
- For sole traders that earn between £0 and £100,000, you will have the aforementioned personal allowance of £12,500.
- For those that earn between £100,001 and £125,140, your personal allowance amount will decrease by £1 for every £2 of income you have over £100,000.
- Those with an income that exceeds even £125,140 will not have a personal allowance.
Sole Trader income tax rates
As a sole trader based in England, Wales or Northern Ireland, the income that you earn above your personal allowance will be taxed in the following ways:
- Earnings below the personal allowance amount (£12,570) are not taxed.
- Earnings of between £12,571 and £50,270, or what’s also known as the Basic Rate, will pay a tax rate of 20%.
- Earnings of between £50,271 and £150,000, or what’s also known as the Higher Rate, will pay a tax rate of 40%.
- Finally, earnings over £150,000, or what’s also known as the Additional Rate, will pay a tax rate of 45%.
As a sole trader based in Scotland, the income that you earn above your personal allowance will be taxed slightly differently to the UK, involving additional tax rates:
- Earnings below the personal allowance amount (£12,570) are not taxed.
- Earnings of between £12,571 and £14,667, or what’s also known as the Starter Rate, will pay a tax rate of 19%.
- Earnings of between £14,668 and £25,296, or what’s also known as the Basic Rate, will pay a tax rate of 20%.
- Earnings of between £25,297 and £43,662, or what’s also known as the Intermediate Rate, will pay a tax rate of 21%.
- Earnings of between £43,663 and £150,000, or what’s also known as the Higher Rate, will pay a tax rate of 41%.
- Finally, earnings over £150,000, or what’s also known as the Additional Rate, will pay a tax rate of 46%.
Sole Trader National Insurance rates
The final responsibility to be aware of as a sole trader in terms of taxation and finance is the payment of National Insurance Rates. In addition to income tax, you’ll need to pay National Insurance contributions to the HMRC in order to qualify for certain benefits and the State Pension. Your contributions are paid into a fund, from which some state benefits, including the state pension, statutory sick pay or maternity leave are produced.
As a sole trader, the amount you need to pay depends on your profits and is divided into two distinct classes; Class 2 and Class 4. The National Insurance tax rates for both of these classes can be found below:
Class 2 National Insurance:
- For all profits below £6,515 per year, no Class 2 National Insurance is required to be paid by Sole Traders.
- For all profits of £6,515 and above per year, you will need to contribute £3.15 a week.
Class 4 National Insurance:
- For all profits below £9,568 per year, no Class 4 National Insurance is required to be paid by Sole Traders.
- For all profits between £9,568 and £50,270 per year, you will need to contribute 9%.
- For all profits over £50,270 per year, you will need to contribute 2%.
Manage Sole Trader tax correspondence remotely
As your sole trader business grows and develops over time, you’ll have to adapt your understanding of how you’re taxed and the best way to manage this. HMRC will often send out mail correspondence letting you know if they need any information from you, and if there’s something that needs your attention.
We offer a virtual address and online mail management solution that allows you to handle any related post from wherever you are. Your virtual address can be used in place or your personal address for business-related mail, and our platform allows you to read, reply, store, and more. To learn more about this service, visit our page around virtual business addresses, or learn about the UK Postbox platform features.