Sole trader tax – a concise guide for the self employed

In this guide, we look at the taxes you will encounter if you start your own business as a sole trader 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. It is an important decision and one that is influenced by your personal situation and long-term plans for your business.

This guide has been updated for the 2023-4 tax year

Sole trader tax vs. limited company tax

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 owners and directors, whereas sole traders (and partners in partnerships) and their business are 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 from the company.

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

Registering as self-employed

It is very quick and easy to register as self employed. For full details of what the process involves see our dedicated guides on;

• How to register as self employed and
• 5 Things you must do when you go self employed.

Self Assessment Tax Returns

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

The days of submitting a paper tax 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 tax return is the 31st October after the end of the tax year in question. Filing your tax online gives you an extra 3 months to complete your return as the deadline for submitting a return online is the 31st January after the end of the tax year.

For example, for the tax year running from 6th April 2021 to 5th April 2022, a paper tax return will need to be submitted to HMRC by 31st October 2022. If you opt to do it online, you will have until 31st January 2023 to submit it.

Any tax you owe for that tax year must be paid in full by the 31st January deadline.

When completing your return make sure you avoid these 10 Common self assessment tax return mistakes.

Payments on account

Once you have started to pay tax through the annual self assessment tax system, you will also have to make ‘payments on account’. These are essentially advance payments for the tax you are likely to owe for the current tax year.

Payments on account are payable to HMRC in two instalments every year, the first on 31st January and the second on 31st July. Each payment is equal to half the amount of tax you owe for the previous tax year.

If you are paying tax via self assessment for the first time, you need to watch out as this might make your first tax bill much bigger than you were expecting.

It’s therefore important that you take this into account and put aside enough money to cover your tax bills when they are due. If you are late filing your tax return or paying your tax, HMRC will fine you.

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

Payments on account – an example

If you started your business in May 2022, you need to complete a self assessment tax return for the tax year from 6th April 2022 to 5th April 2023.

You need to complete the tax return for this period and pay any tax you owe to HMRC by 31st January 2024.

In addition to your tax bill for 2021/22, you will also need to pay the first payment on account for the 2022/23 tax year by the same date.

If your self assessment tax bill for 2022/23 was £10,000, you will need to pay this, plus an additional £5,000 payment on account (half of the tax owed for the previous tax year) for the 2023/24 year by the same 31st January 2024 deadline.

You will also have to pay a second payment on account of £5,000 by July 31st 2024.

Sole trader tax – how much will I pay?

For the 2023/4 tax year, the personal allowance is £12,570. This is the amount you can earn before paying any income tax at all.

For income in 2022/23 above this threshold, you will be taxed at the following levels;

• The Basic Income Tax rate of 20% on income between £12,571 and £50,270
• The Higher Income Tax rate of 40% on income between £50,271 and £150,000
• The Additional Income Tax rate of 45% on income over £125,140.

For ideas on how you could pay less tax, read; 10 Ways small business owners can pay less tax

Try our sole trader tax calculator to work out your tax bill for the current tax year.

National Insurance Contributions (NICs)

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

There are currently two types of NICs sole traders have to pay.

Class 2 and Class 4 NICs

There are Class 2 NICs – which are £3.45 per week – if your profits are above £6,725 (2023/24 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.

Your liability is based on the amount of profit your business makes; 9% on your earnings between £12,570 and £50,270, 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 £85,000 (for the year from April 2023) over a 12 month period, you must also register your business for Value Added Tax (VAT).

When you are VAT-registered you will need to add VAT to all your bills. You will also be able to reclaim the VAT you have paid on business costs.

In some circumstances, it may be beneficial to register your business for VAT, even if your turnover is below the VAT threshold. This is usually the case if the majority of your clients are business customers who can reclaim the VAT you charge them.

Get more detailed help on VAT in;

• ByteStart’s 60-second guide to Value Added Tax (VAT) for start-ups and small businesses
• 21 Costly VAT Mistakes businesses make on their VAT Return

Having a dedicated 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 more accurate financial records, and save valuable time for you and your accountant when it comes to producing your accounts, if you do have a distinct business bank account.

Even if you wanted to use your personal bank account, many banks will stop you from using it for business purposes if the number of transactions increases significantly.

Most banks offer 12 to 18 months of free banking for a new business. After this, you’ll typically be charged a monthly account fee of around £6.50/month for a business current account, plus transaction fees.

As a Bytestart visitor, you can take advantage of an excellent promotion running for a limited time – simply open a Tide business account, and you will qualify for £50 cashback – even if you use it as a secondary account.

ANNA Money is also a very popular current account for small business people – you can set up an account (including sort code and instant payment link) in under 10 minutes, which is remarkable!

Keeping accurate financial and 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.

Online accounting software can be a big help

These days there are online accounts packages that can simplify the financial side of things and save you time.

Most include a facility for you to create and send invoices, track payments, link directly to your bank account, log expenses and automatically calculate your VAT.

Some of the online accounting packages available let you have a free trial so you can try them out and see whether they suit you. Those offering a free trial include FreeAgent.

If you register for a 30-Day Free Trial with FreeAgent here you will enjoy a 50% discount on your first 6 months, PLUS a 10% Lifetime discount for ByteStart users.

Our guide on How to choose the best online accounting software for your business tells you more about how online accounting works and help you to make the right choice.

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