Tax basics for sole traders

Sole trader tax

The amount of business tax you need to pay as a Sole Trader is based on your business profits, and calculated using an annual Self Assessment tax return.  Even if you’re still employed you must declare your self-employed earnings by using the ‘self-employed income’ sheets of the self-assessment return.Here’s what you need to know about business tax.

Self-Assessment tax returns

If you’re a sole trader the tax you owe is calculated via a Self Assessment tax return.  This means:

  • You need to submit an annual tax return to HMRC (Her Majesty’s Revenue and Customs) showing how much you’ve earned from
    self employment and what costs you’ve incurred.
  • Your tax return figures should be for the tax year which starts on 6th April each year and runs through to 5th April the following year.
  • You pay personal tax on your business profits.  Your profit is your income minus certain business expenses. To find out what business expenses you can include see the allowable expenses for tax page on the HMRC website.
  • Your personal tax allowance is deducted from your profits to calculate the amount of tax you owe, unless it’s already been used elsewhere (eg if you also have paid employment).

Accounting software like KashFlow will do all the calcuations you need to fill in your self-assessment tax return at the press of a button.  Find out more about KashFlow and take a free trial here.

National Insurance contributions when you’re self-employed

  • You pay standard rate Class 2 National Insurance Contributions (NICs) (£2.80 per week in 2015/2016)  This is usually paid quarterly.
  • If you’re earning below the small earnings threshold (£5,965 per year in 2015/2016) you can apply for a Class 2 NICS exemption.
  • You also pay Class 4 NICS on your profit.  In 2015/2016 the Class 4 National Insurance rate is 9 per cent of profits between £8,060 and £42,385 and 2 per cent on any profit over £42,385.  Class 4 NICS are calculated and paid for when you do your self-assessment tax return.

Self assessment tax return deadlines

You’ll receive a notice to complete a tax return soon after the new tax year begins in April.

If you complete a paper tax return it’s got to be completed and returned by midnight on 31 October.  Once the forms have been received HMRC will calculate how much tax you need to pay and send you a bill.

It’s much easier if you complete your sole trader tax return online.  You have until 31 January to complete it and you’ll see how much tax you have to pay straight away.

NB If you miss the tax return deadline date by just one day you get an automatic fine of £100 for completing your tax return late, and the fine goes up the longer you take to send in your completed tax return.

Business Tax advice

Take a look at this range of books on business structure and tax outlining some of the different approaches you can take to managing your business tax.

Claiming business expenses

To find out what business expenses and allowances you can claim go to one of HMRC’s ‘Self assessment for self-employed people’ workshops.  These workshops cover what is, and what’s not, an allowable expense.  You also get guidance on how to keep proper business records and how to complete the self-assessment forms.

Book an HMRC workshop on claiming business expenses.

Paying your tax bill

You get your main tax bill sometime in January.  For your first year in business this bill will be for the tax you owe for the previous tax year (eg the tax you pay on 31 January 2014 will be for the tax year 6th April 2012 to 5th April 2013).  Payment is due before 31st January, so you won’t have much time to find the money if you haven’t already saved it!

What is a ‘Payment on account’

Payments on account are part payments towards the next year’s tax bill.  So on 31 January as well as paying tax on the previous year’s profits you pay half of the tax due for the current tax year.  This is an estimated figure based on your previous year’s earnings. You don’t always have to make a payment on account – it depends on the amount of tax due and the kind of income you receive.

You get another tax bill in July, so don’t stop saving once you’ve paid your January bill.  This July bill is to pay the rest of the tax you owe on the profits you have made in the previous tax year.

What is the ‘balancing figure’

After taking into account the ‘payment on account’ you paid at the end of January and the tax you paid in July, any credit or additional amount that needs to be paid will be made at the end of the following January.  This payment or refund is called the ‘balancing figure’ and it’s there to make sure you pay exactly the right amount of tax.

So, for the second and subsequent years you’re in business, your January tax bill will be the the balancing figure for the previous year plus the payment on account for the current tax year.

Example of tax payment dates

You must always pay any tax you owe for the previous tax year by 31 January.

So, if your first year of business is in the 2012/2013 tax year:

On 31 January 2014 you’ll pay

  • Tax on the profits for the whole of the tax year 2012/2013
  • PLUS a payment on account for 2013/2014 tax year

And on 31 July 2014 you’ll pay

  • The rest of the tax due for 2013/2014 tax year

And in January 2015 you’ll pay

  • The balancing figure from 2013/2014 (if there is anything outstanding)
  • PLUS a payment on account for 2014/2015