Sole trader self assessment tax guide

One of the first and most important decisions to be made when you start your business is the legal structure.

There are two main options open you – either to set up a limited liability company and become a director and employee of that, or to be a self-employed sole trader.

Financially, the biggest difference between the two is how you are assessed for tax by Her Majesty’s Revenue & Customs (HMRC). Limited companies are legal entities in their own rights, and are assessed on their turnover and profit with a company tax return.

Sole traders are self-employed and must complete a self assessment tax return every year. Unlike being an employee, you won’t be taxed on your income. Instead you will be allowed to deduct business expenses and be taxed on the profit you have made.

Here are the basics you’ll need to stay on top of:

Check you are truly self-employed

An employee would have extra tax benefits if they claimed self-employed status, so it’s vital to be able to demonstrate that you are truly self-employed. This is particularly important if you are running a small business in your spare time and are employed in a day job (it is possible to do both in the taxman’s eyes).

Your accountant will be able to give specific advice.

Register as self employed

This is quick and easy – but you must remember to do it by the end of your third month of self-employment, otherwise you could be fined.

You can find out how to register as self employed on the HMRC site, or call the Newly Self-employed Helpline on 0845 915 4515

Get a business bank account

Even as a sole trader you should have a separate business bank account. This will make it easier for you to do your tax return, and keep track of how much money your business actually has.

Keep accurate records from day one

To be able to fill out a self-assessment tax return correctly, you need to keep a clear record of all your sales and purchases. This includes all invoices you have issued and received, plus any receipts.

You will also need to keep a record of money you have personally taken out of the business, such as when you withdraw profits, and of course business bank statements.

All of this paperwork will help you work out what profit your business is making. It can be as simple as revenue in, minus expenses out… although some purchases may not be counted as genuine business expenses. Whatever is left is your profit and what you will be taxed on.

There are some allowances you can use to reduce the tax impact such as capital allowances on any equipment you buy. There is a list of these allowances on the HMRC website, and your accountant will help you work out which apply to you.

What else you’ll have to pay tax on

When you come to fill out your tax return you will also be taxed on any other income you have, such as any salary from paid jobs you have, interest from any savings and investments, rental income form property you own and gains by disposing of assets.

If you are going to turnover £68,000 or more per year (from 1st May 2009), you must also register for Value Added Tax (VAT).

How much tax will you have to pay?

If you are calculating your tax for the 2008-9 tax year, you have £6,035 as a personal allowance: you can earn this without paying any tax. After that you pay either 20% or 40% tax on your earnings depending on how much they are. You will also have to pay national insurance contributions on your earnings.

The rates can be changed in the budget, so check out the latest rates on the HMRC website, or Bytestart's own tax rate section.

What forms do you need?

Once you’ve registered as self-employed you will be automatically sent a tax return soon after the end of the tax year on 5th April. You will need the basic tax return document SA100 and the self-employment pages SA103. These will be sent to you, but you can also download them from HMRC. You may also need additional pages if you have other employment to declare, or specific kinds of investments or earnings. You can find a list of all the forms available here.

Making the tax return process easy

Don’t leave it till the last minute. The deadlines for filing are generous, but the worst thing you can do is put it to one side and forget about it. Deal with your tax return as soon as you can – it’s then a horrible job out of the way.

Tax returns are fairly easy to understand. You just work your way through the questions, giving the information requested. As there is a single tax return for everyone, a lot of the questions will be irrelevant to you. Don’t forget to fill out the extra self-employment pages and any other pages you need.

If you have kept proper records through the year you will find this process fairly easy. By far the simplest way to complete the return is using Self Assessment Online, as it will help you with the calculations. Alternatively, and perhaps more sensibly, get an accountant to do it for you. They will be used to trudging through these kinds of figures, and will help you to ensure mistakes don’t happen.

Your deadlines

The tax year runs from 6th April to 5th April.

Despite it being called self-assessment, you can still get HMRC to crunch the figures for you and work out what tax is due. If you want to send in a paper return, you must do this by 31st October, otherwise you have until 31st January if you are submitting your return online.

If you do your return online the system will work out the figures for you and how much tax is owed.

Self-employed people must pay tax in three instalments. The first payment is “on account” by 31st January, and is usually half of your pervious year’s tax bill. You then have to make a second payment by 31st July, usually the same amount you paid in January. Finally on 31st January the following year you must pay a final balancing payment, calculated from your actual profits for the year. Of course if you have overpaid tax you will get a refund.

This seems complicated but your accountant will be able to show you what it actually means in your situation.

There are automatic penalties for paying tax late, despite the unfairness of payments so near Christmas! Use our handy tax accounting dates article to ensure you don’t get caught out.

Remember to get professional advice from a qualified person before taking any action. Don’t rely purely on information contained in this article.