If you work for yourself as a sole trader, you’ll need to familiarise yourself with the rules on self-employed accounts.
Sole traders have to keep financial records relating to the income generated and expenses incurred while doing business.
At the end of each tax year, you will be required to report your business income and expenses to HM Revenue and Customs (HMRC) and your annual tax bill and National Insurance contribution will be calculated.
What are self-employed accounts?
Sole traders must pay National Insurance (NI) contributions and tax on the money they earn, after allowable business expenses have been deducted.
Tax liability is calculated on the basis of the information in your tax return, making good record keeping and accounting practices important to ensuring you pay exactly what is owed.
Poor record-keeping can lead to a number of problems for the self-employed.
It can lead to incorrect calculation of tax liability, it could mean you fail to set aside enough money for your tax bill, and you could face additional fees and fines for late payment.
Cash accounting or traditional accounting?
One of the first decisions you will need to make when starting to trade is whether you will adopt traditional or cash basis accounting.
Under traditional accounting, income and expenditure is recorded by the date invoices are issued or received.
Under cash basis reporting, income and expenses are reported per the date of payment, meaning you will not be liable for tax on the transactions not yet received. Cash basis is only available to businesses with income of under £150,000.
This is an important distinction to make as it will determine when you become liable for tax on the transaction.
For example if you invoiced for services on 29 March 2020 and were paid on 28 April 2020:
- Under the traditional accounting, the income is recorded on the date of invoice which is in the 2019/2020 tax year.
- Under cash basis accounting, the income is recorded per the date received, which comes under the 2020/2021 tax year.
When are the self-assessment deadlines?
In the UK, the financial year runs from April 6th through to April 5th of the following year; referred to as the ‘tax year’.
Self-employed accounting involves keeping accurate records during this period of everything you have earned, and all the monies paid out ‘wholly and exclusively’ for the purposes of running the business, throughout the relevant financial year.
Once this period is over, you will total up both figures and report them to HMRC by filling out your self-assessment tax return. When this process is complete, you will be told the amount you are liable to pay in tax and National Insurance contributions, if both are applicable.
The deadline for filing your self-assessment tax return with HMRC will depend on how you choose to submit the information. Those choosing to submit their return on paper must do so by midnight on October 31st, following the end of the financial year (the preceding 5th April).
If you opt to complete an online tax return, you will have until midnight on the following January 31st.
However, both types of return can be filed at any point prior to these deadlines once the financial year has ended. Whichever method you use, keep in mind that any tax and National Insurance you owe must be paid in full by January 31st.
It is wise to submit your tax return as soon as your self-employed accounts for the previous financial year are in order, just in case you have miscalculated how much you will need to pay and do not have sufficient funds set aside.
How much is self employed income tax and National Insurance contributions?
Sole traders are generally advised to set aside a percentage of their total earnings each month in preparation for their end of year tax bill to avoid any shortfall or inability to pay.
How much you set aside will depend on your predicted earnings for the financial year.
Income tax is currently set at the following thresholds:
|Income tax thresholds 2020/2021 (after allowances)||Income tax rate 2020/2021|
|Basic Income Tax rate||£12,500 – £37,500||20%|
|Higher Income Tax rate||£37,501 – £150,000||40%|
|Additional Income Tax rate||Over £150,000||45%|
The personal tax-free allowance for 2020/2021 is £12,500. this means the first £12,500 of your earnings are not subject to income tax.
Sole traders may also be liable for National Insurance. NI contributions are set as follows for the self-employed:
Class 2 National Insurance: a flat rate of £3.05 / week, applicable to all sole traders who earn over £6,475 in the financial year.
If your earnings exceed £9,500, you will also be liable to pay Class 4 National insurance, at the following rates:
- 9% of earnings between £9,500 and £50,000
- 2% of earnings over £50,000
How to set up self employed accounts
Your first task when setting up your self-employed accounts will be registering yourself as a sole trader with HMRC.
Once your registration is complete and has been approved, you will be assigned a Unique Taxpayer Reference (UTR) code, that you will need when filling out your self-assessment tax return at the end of each financial year and when paying your resulting tax bill.
When you are ready to begin trading and managing your accounts, consider the following:
Set up a business bank account
Having a separate business account is a legal requirement for limited companies, though not for sole traders. However, it can make your self-employed accounts far easier to manage and help your business to appear more professional.
When you have a dedicated account for business matters, it becomes easier to track and record all transactions for bookkeeping purposes.
Using your personal account will warrant additional work and caution, as you must be able to identify and evidence which transactions were personal, and which were business related. Keep in mind that most business accounts come with a monthly fee and that account benefits vary quite dramatically from one product to another, so it pays to do your research and shop around.
Adopt an accounting system – however simple!
In general, sole trader self-employed accounts are far easier to manage than limited company accounts.
It is important to approach self-employed accounting methodically and diligently from the day you start trading. This means tracking monthly income and expenditure by keeping records of all your sales invoices and receipts.
This will include costs like rent and bills for office space, or a portion of your household expenses if you work from home.
Basic solutions such as spreadsheets are helpful for recording this information and supporting good accounting practices. You could also consider using online accounting solutions to help with bookkeeping, tagging transactions and raising invoices and logging receipts, particularly as your business and the volume and value of transactions starts to grow.
What records do you need to keep as a sole trader?
HMRC has powers to request records when reviewing self-assessment tax returns, you are legally required to keep this information and all supporting documents for six years.
Sales & income
Sole traders must keep an accurate record of all the money they make during the financial year. As this income must be traceable, you should also keep record of services performed and work carried out. Only retail income does not need to be evidenced in this way.
One of the more complicated areas of self-employed accounting is expenses. Allowable expenses must be ‘wholly and exclusively’ necessary for the business (i.e. not something you also use in your personal time) and itemised receipts must be retained for all tax-deductible expenditure.
This could include:
- Money spent on stock
- Delivery expenses
- Heat and light bills
- Bank charges (if they relate to a dedicated business account)
- Telephone and internet
- Subscriptions to industry journals or magazines
- Office furniture
- Consumable office items such as paper, printer ink, staplers, pens, and pencils
Expenditure which is not deemed exclusively for business use would not be tax-deductible, such as training courses not related to the job or business, school fees and gym membership.
If you employ people, you will need to keep detailed records relating to how much they have been paid, any deductions made, details of any leave and absence, tax code notices and any relevant taxable benefits or expenses.
You will also need to keep records relating to your self-assessment tax return. The rules require you to keep these records for at least 22 months after the end of the tax year the tax return is for, or if filed late, at least 15 months after you sent the tax return.
Grants & schemes
If you have received a business grant or are part of a financial support scheme, you may be required to maintain certain records.
Self-employed accounting tips for sole traders
A little and often is good
Leaving it to the last minute to finish your accounts and file your return can lead to problems – HMRC’s systems are likely to be inundated and are known to struggele with the surge in demand, which can lead to technical issues and delays. Avoid a last minute panic and rush to sort your books and file your return by keeping on top of your accounting, at least on a monthly basis.
In addition – set aside funds each month to be able to settle your final tax bill. WHile HMRC may be able to payment arrangements, remember you will be going into a new tax year a new tax liability.
You cannot claim for expenses without a receipt as proof of the expenditure. If you lose receipts, while it is easy to overlook minor costs, but keep in mind that these can add up to quite a sizable sum over the course of the financial year.
Make full use of business expenses
Our guide explains what costs are allowable to help reduce your tax liability and what records (such as itemised receipts) you need to keep for any business expenses you intend to claim on your tax return.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert tax, financial, legal or other advice should be sought.