Becoming self-employed or a sole trader opens up a world of possibilities!

However, it’s important to ensure you’re paying your taxes and national insurance (NI) correctly, as they’re your responsibility to sort out. You also need to report the tax and NI you owe through your Self Assessment tax return.

In this guide, we’ll answer questions about how to do your tax return as a sole trader or self-employed person. So you can stay compliant and focus on your business.

‘Self-employed’ vs ‘sole trader’: what is the difference?

Although the terms are often used interchangeably, there are a few differences between being a sole trader and being self-employed. Essentially, being a sole trader is a status within self-employment.

The general definitions for being self-employed vs being a sole trader are as follows:

Self-employed: ‘Self-employment is the state of working for oneself rather than an employer. Tax authorities will generally view a person as self-employed if the person chooses to be recognised as such or if the person is generating income for which a tax return needs to be filed.’

Sole traders: ‘A sole proprietorship, also known as a sole tradership, individual entrepreneurship or proprietorship, is a type of enterprise owned and run by one person and in which there is no legal distinction between the owner and the business entity. A sole trader does not necessarily work alone and may employ other people.’

With this in mind, there are a few differences in how self-employed individuals and sole traders pay tax, which we’ll cover in this guide. 

How much do sole traders and the self-employed earn before taxes?

If you’re self-employed in the UK, you pay income tax on your profits, not your total earnings. However, you can earn a certain amount of money before you have to start paying taxes.

And if you’re also a sole trader, you can deduct business expenses from your income.

How does Self Assessment work for sole traders?

Self Assessment is how you report your income to HMRC and calculate any tax you owe. Here’s how Self Assessment works if you’re a sole trader and self-employed.

• Register - if you’re a sole trader, you need to let HMRC know as soon as you can by registering as a sole trader or self-employed. They’ll send you a Unique Taxpayer Reference (UTR) once you’re registered.

• Make records - make sure you’re making accurate financial records for your business, including all receipts, invoices and any other financial documents.

• Do your tax return - using the online portal, complete and submit your tax return. You can read our comprehensive guide to doing your Self Assessment here.

• Pay your tax - HMRC will calculate how much tax you owe, including any deductions, based on the information you provide. Pay it before the deadline.

How is profit calculated for sole traders and the self-employed?

Profit and loss are calculated by taking the total sales of a business and subtracting its costs and overheads. However, not all costs that are allowable for accounting purposes are deductible for tax purposes.

Calculate your sole trader and self-employed tax

Struggling to work out what you’ll need to pay as a sole trader or self-employed person for Self Assessment? 

QuickBooks’ Self Assessment tax calculator is tailored for you, and is designed to make it easier than ever to estimate your tax liability based on your business profits. By using this tool, you can plan ahead and manage your finances effectively.

Who needs to file a Self Assessment tax return?

Sole traders and the self-employed need to do a Self Assessment tax return and declare their income if:

• You earned more than £1,000 from self-employment during the tax year

• You need to pay National Insurance contributions e.g. Class 2 or Class 4 NICs

• You received other income that’s classed as taxable, such as dividends or rent

How much National Insurance Contributions do sole traders have to pay?

As a sole trader or self-employed person, you're responsible for paying National Insurance Contributions (NICs) on your profits. NICs are used to fund various state benefits, including the State Pension, so it's crucial to understand how they work and how much you need to pay.

There are two main types of NICs that you need to be aware of as a sole trader: Class 2, which can be paid directly to HMRC, and Class 4. The latter can be calculated and paid via your Self Assessment tax return.

Learn more about the specific limits for Class 2 and Class 4 Contributions and what your responsibilities are with our comprehensive guide to National Insurance for sole traders. 

Personal allowance

Your personal allowance is the amount of income you can earn as a self-employed or sole trader before you start losing a portion of your tax-free allowance. Here’s how it works.

The personal tax allowance for 2023/34 is £12,570, and this is fixed until 2025/26.

This means that if you’re self-employed or a sole trader, you can earn up to £12,570 in profits (not even your total earnings) before you need to pay any income tax at all. 

Are there any exceptions to the personal allowance?

Yes, for every £2 earned above £100,000, the personal allowance is reduced by £1. So once your income exceeds £125,140, your personal allowance is completely removed.

Note: If you’re married or in a civil partnership, you may be eligible for marriage allowance if one partner earns below the personal allowance threshold while the other is a basic rate taxpayer. This allows you to transfer a portion of your unused personal allowance.

Trading & property income allowances

Separate from the personal allowance, trading and property allowances are additional allowances introduced by HMRC. They simplify tax reporting for self-employed individuals, sole traders and landlords, with small amounts of income from either self-employment or property.

What is the trading income allowance?

The trading allowance lets individuals earn up to £1,000 income per tax year from occasional self-employment work, without having to pay tax or report that small-scale income to HMRC. 

What is the property income allowance?

Similar to the trading allowance, the property allowance applies to income made from renting private or commercial property. You can earn up to £1,000 income from renting without reporting it.

If you earn over the £1,000 income threshold for either of these business types you can still claim the allowance but you will need to report the business's full income to HMRC. 

You can either reduce the business income by £1,000 by claiming this allowance or work out the business profits in the traditional way - by reporting the business's full income and expenses to HMRC. The trading/property allowance and business expenses cannot be used in conjunction with one another.

If you use these allowances, you still have the personal allowance for other income sources. 

What if I have two jobs, and one is self-employed?

When you have two jobs (for example, one as a full-time employee and the other as a self-employed freelancer), you need to manage and report your income separately.

As an employee, your employer will deduct your income tax and National Insurance contributions (NICs) from your salary through the Pay As You Earn (PAYE) system. You’ll be able to see these deductions on your monthly payslip, alongside the net pay you receive.

However, if you have a self-employed job alongside being an employee, you’ll need to register as self-employed with HMRC and complete a Self Assessment tax return. 

Here are a few things to remember when sorting out tax if you’re in this situation:

• When completing your Self Assessment tax return, you must include details of your income from employment, including the tax and NICs deducted on payslips. Your employer will provide you with a Form P60 at the end of the tax year, summarising your total earnings and the tax and NICs deducted. This form is essential for accurately reporting your employment income on your Self Assessment.

• The tax code used by your employer might not take into account self-employed income, so it’s essential that you declare and report this income accurately.

• It’s wise to keep detailed records of your income, expenses and tax-related documents for both jobs, in order to keep track of your tax obligations.

You can also check whether you need to tell HMRC about any additional income here.

What if I have other earnings?

If you have other sources of income as a sole trader, such as dividends, interest from savings, or rental income, it’s important to declare this in your Self Assessment tax return.

Your tax return allows you to report all income, so HMRC can calculate your liability and total tax you owe. It’s essential to declare all sources of income, in order to avoid any tax penalties or interest charges. If you have multiple streams, an accountant can help.

How do you pay yourself as a sole trader?

As a sole trader, you can withdraw money from your business account to pay yourself whenever you need it. It’s generally advised to maintain a separate business bank account to keep your finances organised.

How much income tax might I need to pay?

Now you know whether you need to pay tax, how much tax do you pay? This all depends on how much you earn as a self-employed individual, and which income tax band you’re in.

2023/24 Income tax bands for self-employed individuals (not including Scotland)

Income tax bands for self-employed individuals and sole traders (Scotland)

You do not get a Personal Allowance if you earn over £125,140 in Scotland.

As mentioned earlier, if you earn less than £12,570, you may not need to pay any tax. But if you earn over £125,140 in taxable income, your personal allowance is completely removed.

Do I need to pay corporation tax as well?

As a self-employed person or sole trader, you don’t need to pay corporation tax. 

Corporation tax is for private limited companies and limited liability partnerships. It’s important to know the difference between business structures when calculating your tax.

Instead of corporation tax, self-employed individuals pay income tax on their profits. 

Tax deductions & exemptions for sole traders & self-employed

There’s a variety of tax deductions and exemptions for self-employed individuals and sole traders in the UK. They help reduce taxable profits, so you have less tax liability.

Allowable Expenses: Expenses incurred wholly for your business. If you’re a sole trader, these can include office supplies, travel expenses, marketing costs and professional fees. 

Capital Allowances: If you buy assets for your business like equipment or machinery, you can claim capital allowances. These allow you to deduct some of the cost from your profits.

Home Office Expenses: You may be able to claim some household expenses like rent, mortgage interest and bills if you use part of your home for business purposes. 

Pension Contributions: Self-employed people can contribute to a personal pension scheme and receive tax relief on contributions, helping you save for your retirement.

Loss Relief: If your business incurs a loss in a particular tax year, you can carry the losses forward and offset them against future profits. This can help your tax liability in future years.

It’s important to remember tax reliefs and exemptions have strict rules and limitations.

You must keep detailed records of your income and expenses, and seek professional advice from a specialist to ensure that you’re taking full advantage of the reliefs available to you.

The HMRC site provides a wealth of help on the specifics of claiming tax deductions.

FAQs

What if I do my taxes wrong as a sole trader?

If you make a mistake on your tax return as a sole trader, rectify the error as soon as you can. Review your tax return, identify the mistake, and notify HMRC over the phone.

Depending on what the mistake is, you may need to amend your tax return within 12 months of the filing deadline. If the error results in additional tax liability, pay HMRC promptly to avoid penalties. It's essential to be proactive in correcting mistakes to ensure compliance and avoid potential consequences – you may even wish to get professional advice.

What happens if I pay my taxes late?

Late tax payments as a self-employed individual or sole trader in the UK can lead to penalties and interest charges imposed by HMRC. Penalties vary based on the delay and amount owed, while interest accrues on the outstanding balance. Plan ahead, and if you anticipate difficulties, contact HMRC promptly to explore options like setting up a payment plan. 

Can I be investigated by HMRC?

HMRC may investigate your tax affairs at any time, but they won’t do this without notifying you first, either by letter or official notice. There are three types of HMRC investigation: a full enquiry, an aspect enquiry, or a random check. 

A full enquiry involves a full review of all your business records, usually due to a significant risk of error in your tax. An aspect enquiry focuses on inconsistencies in a specific part of your records, which is the most common type of investigation. 

Lastly, a random check is a random inspection that is usually as detailed as an aspect enquiry. HMRC can investigate records up to six years old, so it is crucial to keep evidence for all tax relief claimed over the last five years.

Do I pay tax in my first year as a sole trader?

Regardless of whether it is your first year or subsequent years of trading, you have to pay income tax and NICs if you’re above the thresholds detailed above. If your self-employment income is below the applicable thresholds, you may not have to pay any income tax at all.

Found this article about paying tax when you're self-employed useful? Using software like QuickBooks is a great way to make sure you stay on top of your taxes.

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