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.
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.
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:
As well as the responsibilities above, you will need to fulfil the following if the scenarios described apply to you or your business:
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.
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:
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.
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:
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:
The amount of money you need to pay as a Sole Trader for income tax depends on a variety of different factors, including:
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:
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:
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:
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:
Class 4 National Insurance:
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.
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