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Sole trader tax – a guide for start-ups and the newly self employed

October 7, 2011

In this concise guide, we look at the taxes sole traders will encounter, and other things you should bear in mind before taking the plunge and becoming self employed.

Before you start up in business, one of the first decisions you need to make is which business structure to work under.

The most popular options are to set up your own limited company or to work as a sole trader.

Sole trader businesses and limited companies taxed differently

One of the most fundamental differences between the two types of business structure is how each one is assessed for tax purposes.

A limited company is taxed as a separate legal entity from its directors, whereas a sole trader and his/her business is taxed as one single entity.

Limited companies are subject to Corporation Tax on their annual profits, and directors must fill in an annual self assessment return to cover any income they have drawn down.

All self employed people (sole traders and partners in a partnerships) are taxed via the self assessment system each year, and pay tax on their business profits after deductions for expenses.

How to become self-employed

It is very easy (and fast) to register as self employed. All you need to do is inform HMRC within 3 months of starting work on your own.

You can find out more in our dedicated article on how to register as self employed.

Self Assessment Tax Returns

After you have registered as a self employed person (or as a member of a partnership), you should automatically be sent a self assessment notice following the end of each tax year (which runs from 6th April to 5th April).

The days of submitting a paper return are almost behind us, with HMRC encouraging all taxpayers to submit their self assessment returns online these days.

This is the most surefire way to submit your return. You can find out more at HMRC’s Self Assessment Online.

The deadline for submitting a paper return is 31st October, and the deadline for submitting a return online (and for making full payment of your tax liabilities) is 31st January.

If you owe any tax, you will also have to make ‘payments on account’ on 31st January and 31st July, presuming that you are likely to owe the same amount of income tax in the following tax year.

If you believe your income for the following year will be significantly lower, you can apply to HMRC to reduce your payments on account.

Of course, for a fee, an accountant will take care of your self assessment for you.

How much will my tax bill be?

For the 2014/15 tax year, the personal allowance has been increased to £10,000. This is the amount you can earn before paying any income tax at all.

For income above this threshold, you will be taxed at the following levels;

The Basic Income Tax rate of 20% on income up to £31,865,
The Higher Income Tax rate of 40% on income between £31,866 and £150,000,
The Additional Income Tax rate of 45% on income over £150,000.

National Insurance Contributions (NICs)

In addition to income tax, as a sole trader, you will also need to make national insurance contributions (NICs). The amount you have to pay depends on the level of your earnings.

There are two types of NICs sole traders have to pay. There are Class 2 NICs – which are currently £2.75 per week (2014/15 Tax Year) – and Class 4 NICs.

HMRC will work out the amount of Class 4 NICs you are liable for during the annual self assessment process. It is based on the amount of profit you make, essentially 9% on your earnings between £7,956 and £41,865, and 2% on any profits above this.

Other types of tax – VAT

The self assessment process will take care of most of your tax obligations – it includes details of any income you have received from savings and investments, the disposal of assets, or income from renting out property.

If your business has a turnover of more than £81,000 (for the year from April 2014) over a 12 month period, you must also register your business for Value Added Tax (VAT).

Business bank account

Although there is no legal requirement for the self employed to have a separate business bank account, it will help you keep accurate business records, and many banks will not allow you to use your personal account if the number of transactions going through it increases significantly as a result of starting up in business.

Find out more about how to set up a business bank account.

Keeping accurate business records

Aside from keeping on top of your business cashflow, keeping clear and accurate records of all your sales and expenses is crucial to the survival of your new business.

You should keep all your receipts, invoices, bank statements, and any other paperwork, in a safe place.

You may be able to claim various allowances to reduce the amount of tax you have to pay on your business profits. You can view a list on the HMRC site, and make sure you ask an accountant if there are ways you can save tax.

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