If you decide to work for yourself and begin trading as a sole trader, (self-employed) you will need to set up your accounts to record your income and expenses.
In order to do this you will need to be aware of tax, national insurance and other factors that will affect the records you need to keep as a sole trader.
To help you understand your duties and to get your book-keeping done painlessly, here’s the low-down on setting up your sole trader accounts.
1. Open a separate bank account
A sole trader is not legally separate from their business, so a separate business bank account is not a legal requirement. However, there are definite advantages to keeping you business and personal finances separate.
If you only have a personal bank account you will have to be more explicit in your records and specify which expenses were personal and which were business related. This will affect how you record expenses and income, and will take you more time.
Having a separate business bank account will allow you to easily record business expenses and income, which will make completing your annual accounts and Self Assessment Tax Return (see below) less time consuming.
2. Know your tax and National Insurance rates
As a sole trader you will be required to set aside money for tax each year, which is recorded by your Self Assessment. It is therefore vital to be aware of income tax thresholds and the National Insurance Contributions (NICs) you will be required to pay.
Each individual receives a Personal Allowance on taxable income that they do not have to pay tax on. The standard Personal Allowance for the tax year 2020/21 is £12,500.
For income above the Personal Allowance, you will be taxed at the following levels:
- The Basic Income Tax rate of 20% on any income up to £50,000
- The Higher Income Tax rate of 40% on any income between £50,001 and £150,000
- The Additional Income Tax rate of 45% on any income over £150,000.
Sole traders also pay Class 2 and Class 4 NICs. Class 2 NICs are payable directly to HMRC, while Class 4 NICs are payable through Self Assessment.
You will be required to pay Class 2 NICs of £3.05 a week (2020/21), if your profits are £6,475 or more a year.
You will pay Class 4 if profits are £9,500 or more a year (9% on profits between £9,500 and £50,0000 and 2% on profits over £50,000).
You must contact HMRC directly to pay your NICs. The easiest way to pay is to set up a direct debit.
You can find more details on tax and NI for the self employed in,
- Sole Trader Tax – A guide for start-ups and the newly self employed
- Guide to National Insurance Contributions (NICs)
Compared to a limited company, the work involved with bookkeeping as a sole trader is minimal. You should track monthly income and expenditure. In order to do so you must keep records of all your invoices and receipts.
You should keep receipts of any work transactions as well as rent and bills. If you own an office, or if you work from home, you may be able to claim rent and bills back from HMRC as a business expense.
A spreadsheet for recording your business transactions is a good solution for some, but can limit your capabilities. Spreadsheets work best for those who want to record transactions by inputting data themselves and for those who prefer to send their own invoices.
Alternatively, you may use bookkeeping software or an online accounting package to record your business expenses and income.
Online accounting systems are becoming more and more popular with small business as they offer extra features such as invoice creation and automatic feeds from your bank account. These features cut out duplication so save valuable time.
There’s a wide range of options available and you can find out more on how to find the right one for you, in this guide on How to choose the best online accounting software for your business.
4. Claim business expenses
As a sole trader there will be a number of business expenses you can claim back from HMRC. These can include:
- Cost of stock
- Delivery charges
- Heating and lighting in your business premises
- Rent of your business premises
- Relevant books and magazines
- Bank charges
- Telephone use
- Bank charges on business accounts
Expenses you may not claim include:
- Parking fines
- Speeding tickets
- Client entertainment
- School fees
- Gym membership
- Hairdressing costs
- Training courses that are not related to your job
If you’re a sole trader working from home, it’s worth noting that some of your household expenditure may also be tax deductible. You can find out more about how sole traders could pay less tax in these guides;
- Could you cut your tax bill by claiming some of these business expenses?
- How using ‘simplified expenses’ can save you time if you’re self employed
5. Complete a Self Assessment Tax Return
All sole traders will have to complete an annual Self Assessment Tax Return and submit this to HMRC. The Self Assessment provides HMRC with information on your income and expenses, and makes sure you are taxed the correct amount.
When you register as a sole trader with HMRC, you will be enrolled to complete an annual Self Assessment Tax Return. If you don’t register in time you may be charged a penalty.
Completing the Self Assessment is easier if you have detailed and clear business records and if you have an online account with HMRC, as this will speed the process up. Make sure you don’t make any of these 10 Common Self-Assessment Tax Return mistakes.
If you aren’t confident you can do your self-assessment without making any mistakes, then you should consider hiring an accountant to complete one on your behalf, for a reasonable fee.
6. Payments on account
Payments on account are advance payments of Income Tax and Class 4 NICs that some have to pay for a future tax year.
You will have to make a payment on account if:
- Your Income Tax and Class 4 NICs total more than £1,000
- You don’t pay tax at source (tax on income before you receive the payment) on more than 80% of your income
Payments on account are due on 31st January and 31st July.
7. Register for VAT if necessary
You must register for VAT if:
- Your turnover is more than £85,000 in a 12 month period
- You receive goods in the UK from the EU with a value in excess of £85,000
- You expect to go over the threshold in a single 30 day period.
However, registering for VAT can be preferable in certain circumstances even if you’re below the threshold.
For example, if you wish to be perceived as a larger company being registered for VAT will give this perception with the allocation of a VAT registration number that you can display on your company website.
Being VAT registered will also allow you to recover any VAT you pay on purchases for the business. If you’re registered for VAT you must keep all information for 6 years.
These guides will give you more help on dealing with VAT;
- 21 Costly VAT Mistakes businesses make on their VAT Returns
- A Guide to the Flat Rate VAT Scheme & the Limited Cost Trader test
- Checking to see if a VAT registration number is valid – Why it’s important, and the best way to do it
This advice was provided exclusively for ByteStart by Lauren Wise from The Accountancy Partnership.
Last updated - 3rd October, 2019