When you start up as a sole trader or partnership, you will be liable for a series of business-related taxes, as well as the ones you will have been used to as a normal employee.
Here are the main tax differences to be aware of, and what your liabilities are.
As an employee working for someone else, all you have to do is turn up every day and get a wage slip once a month. Your employer works out how much tax and National Insurance you have to pay and deducts it from your salary before you even see it. They even pay it to HMRC on your behalf.
As a self-employed person, this is all your responsibility.
The main difference as a sole trader is that you aren’t taxed on your salary, as you don’t really have one. Instead, you must work out how much profit your business makes, by deducting the costs of running your business from your revenue. This profit is what you must declare to HMRC and pay tax on.
Costs that you can claim include supplies to produce goods, rent on business premises, travel expenses, the costs of admin, and, of course, any employees.
Capital purchases such as equipment are typically offset against your tax over several years. This is the kind of thing your accountant will work out for you. Speaking generally though, the more legitimate business expenses you have, the less income tax you will pay.
Paying income tax
The current tax rates will determine how much of your profit you will pay as tax. Get used to putting a proportion of your revenue aside for tax from day one, and you could ultimately be in the pleasant situation of having more saved than your tax bill. Use a separate account to do this and avoid the temptation to raid the account unless it’s a dire emergency.
Every year HMRC will send you a self assessment tax return, where you work out your own tax bill. And you will have to make payments twice a year in instalments, known as payments on account.
NI is fairly simple when you are self-employed. Again, you pay these liabilities via the annual self assessment process.
For the 2021/22 tax year, you pay Class 2 contributions at a fixed rate of £3.05 a week, and if your profit is more than £9,568 a year, you will pay additional Class 4 contributions @ 9% of your total annual profits. You pay 2% on profits above £50,270. For the latest NI rates, read our guide to NI for small firms.
Are you self employed?
Employment status rules may determine whether or not you are ‘self employed’ or ’employed’, as per HMRC’s use of each term.
It is possible to be employed by someone and run your business as a self-employed person, even if it’s only on a part-time basis.
If you are running a limited company, and work as a contractor or freelancer, you should also ensure that your working conditions, as well as any contract terms, show clearly that you are in ‘business on your account’, not merely an employee still in the commonly understood sense of the word, otherwise you may be caught by the IR35 rules.
One tax that will be new to you as a self-employed person is Value Added Tax, which you already pay when you buy goods.
VAT is a tax that is collected by businesses on behalf of the government. Once registered, you must charge it to your clients, and pass it onto HMRC with a VAT return.
It is compulsory to register for, and start collecting, VAT when your revenue for the previous 12 months is more than £85,000 (from April 2021).
This is a rolling period so keep a close eye on your turnover, as you will be fined if you don’t register within 30 days of reaching the VAT registration threshold.
Last updated - 6th October, 2016