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Sole Trader Tax

At the beginning of 2020, 3.5 million sole traders were registered and operating in the UK, accounting for 59% of the private sector business population. Since 2000, the number of non-employing businesses has grown by 2.2million, an increase of 94%, showing a fast-growing trend in working for yourself. As the modern business world evolves and people search for a way to turn their skills and passions into a legitimate career, this number is expected to inflate.

While starting as a sole trader is quite a straightforward process, specific regulations must be adhered to to ensure you comply with business taxation laws.

What is a Sole Trader?

When deciding to set up your own business or become self-employed, you first need to select whether to register as a sole trader or a limited company.

Sole traders operate as individuals and are self-employed. They have complete responsibility for ensuring the company is fully compliant with UK business tax regulations and must register with HMRC, either using their own name or their company name. In addition, if the business makes losses, sole traders are personally responsible for paying back any debts. 

Various forms of self-employment would be suitable to register as a sole trader, for example:

  • Tradespeople (Gardeners, Plumbers, Handy Men etc.)
  • Hairdressers
  • Mobile Beauty Therapists
  • Dog Groomers 
  • Dog Walkers or Pet Sitters
  • Childminders

Limited companies generally have a more intricate business structure than sole traders and operate as their own legal entity. This means that the directors or owners of the business are not personally vulnerable to any debts or losses that they might amass. Limited companies must appoint at least one director and be registered with Companies House and HMRC for Corporation Tax.

What Tax Does a Sole Trader Pay?

The tax year runs from 6th April to 5th April the following year in the UK. Sole Traders must pay income tax depending on their total annual profits (minus expenses) for each tax year. 

Additionally, Sole traders must pay Class 2 and 4 National Insurance Contributions (NIC).

If your annual turnover exceeds £85,000, you will also need to register for Value Added Tax (VAT) which is applicable for most services and goods. You will be required to charge VAT on your sales but can also reclaim it on purchases made by the business.

How is a Sole Trader Taxed?

HMRC calculates how much income tax a sole trader is required to pay from the information supplied on an annual self-assessment tax form. 

Each year, sole traders are allocated a personal allowance that they can earn tax-free. This is the same tax-free amount as those employed through PAYE. In the current tax year (2021/22), this allowance is £12,570. Any profit over this amount will be taxed accordingly. 

As sole traders work for themselves, they must ensure their tax self-assessment is completed on time each financial year. Although self-assessments are usually done online, paper copies are also available. 

Sole traders do not legally need to register their company with HMRC until the October following the first tax year they began trading. It is, however, always advisable to register as soon as possible.

After registering as a sole trader with HMRC, you will receive information on accessing your self-assessment online account through Government Gateway. In addition, sole traders will be sent reminders from HMRC that their self-assessment is due throughout the year.

Even if you have only made a small profit or even a loss, you must still complete your self-assessment form each year. HMRC will then inform you that no tax is due and offer the opportunity to pay Class 2 NIC to ensure you qualify for certain benefits in the future, although this is not compulsory.

Self-assessment tax returns must be completed before the deadline of 31st January each year. 

When Does a Sole Trader Pay Tax?

After completing your self-assessment tax return form, HMRC will notify you of how much you are required to pay and by when. Depending on the profits declared in a tax return, some businesses may also be required to contribute payments towards their next years’ bill as well. These payments will be due at the end of July and January.

There are various ways to pay, and in certain circumstances, you may be allowed to set up a payment plan.

How Much Does a Sole Trader Pay?

The tax sole traders must pay is dependent upon their annual profits. Therefore, the more profit your business makes, the higher the tax bill. 

As previously mentioned, sole traders are given a personal allowance (currently £12,570) that they can earn tax-free.

If your earnings surpass the personal allowance, you will be required to pay the following income tax:

  • Basic Income Tax Rate of 20% for earnings between £12,570 and £50,270
  • Higher Income Tax Rate of 40% for earnings between £50,271 and £150,000
  • Additional Income Tax Rate of 45% for earning overs £150,000

Additional to income tax, sole traders must also make National Insurance Contributions. 

Class 2 NIC is applicable for annual profits over £6,515. However, if your earnings are under this threshold, you can still choose to make voluntary contributions, as Class 2 NIC provides eligibility to certain benefits in the future, such as maternity or paternity pay. For the current financial year (2021/22), the rate for Class 2 NIC is £3.05 per week.

Class 4 NIC is for annual profits over £9,569. It is calculated as a percentage of total yearly profit as follows:

  • 9% on profits between £9,569 and £50,270
  • 2% on profits over £50,270

Turning over more than £85,000 per year will also mean a sole trader is liable for paying VAT. At this point, you may want to speak to a sole trader accountant to find out more.

How Does a Sole Trader Pay Tax?

Following notification from HMRC on the amount of Income Tax and NIC you owe, sole traders are responsible for ensuring their bill is paid on time.

There are several ways to pay your tax bill, including:

Same or Next Day Services:

  • Online Banking
  • Telephone Banking
  • In-Person at your Bank or Building Society
  • Chaps

Services Within 3 Working Days:

  • BACS
  • Cheque in the Post
  • Direct Debit (Please note: this must have been previously set up with HMRC; otherwise, it will take up to 5 working days to clear)

When deciding which payment method to use, it is essential to remember to allow enough time for payments to clear as HMRC will issue a fine for some traders or businesses that fail to pay the tax they owe on time. Also, consider whether the payment deadline falls on a weekend or bank holiday to ensure payments clear beforehand.

If you have trouble paying your income tax bill in full, you may be able to arrange a payment plan with HMRC and pay in more manageable instalments.

How an Accountant can Help with your Self-Assessment

If you are newly self-employed and finding the self-assessment process confusing or overwhelming, you may wish to contact a professional online accountant, who will be able to help. Accountants are highly proficient with all financial matters and can ensure that self-assessment tax returns are completed accurately before the 31st January deadline.

If you would like any further information on sole trader tax, please get in touch with me!