Among the responsibilities of working for yourself is ensuring you meet your sole trader tax liabilities.
The following guide on sole trader tax provides a look at the rules relating to income tax, national insurance contributions and VAT for self-employed workers, from what rates of tax you will be liable to pay on your trading profits to some of the common pitfalls.
What is sole trader tax?
As a sole trader you will pay income tax on any business profits you have made, minus allowable expenses, while working on a self-employed basis. This is in addition to any Class 2 and Class 4 national insurance contributions.
The amount of tax payable will depend on how much taxable income is above your personal allowance and how much of this income falls within each tax band for the relevant year.
For the tax year 2022 to 2023, the personal allowance threshold is £12,570. This means that any income earned below these amounts, assuming your earnings do not exceed £100,000, is tax-free.
If you are eligible to claim either the marriage allowance or blind person’s allowance, your personal allowance may be higher.
Income tax is then paid on the amount of taxable income remaining after any applicable allowances have been deducted.
If you earn significantly over £100,000 in any given tax year, your personal tax allowance could be zero. As a high earner, the allowance will be reduced by £1 for every £2 that your adjusted net income is above the £100,000 threshold. This means, for example, that if your taxable income for the 2021 to 2022 tax year is over £125,140, you will not have any remaining personal allowance before you have to start paying tax.
Sole trader tax rates
For the tax year 6 April 2022 to 5 April 2023, if you have a standard personal allowance of £12,570 you will not pay any tax on this amount. For any taxable income earned over and above this amount, the following bands and rates will apply:
- Basic rate 20%: £12,571 to £50,270 (ie up to £37,700 without the personal allowance)
- Higher rate 40%: £50,271 to £150,000 (£37,701 to £150,000)
- Additional rate 45%: taxable income over £150,000.
There are different income tax bands and rates if you live in Scotland.
Sole trader national insurance rates
There are two different types of national insurance for sole traders, depending on your profits: Class 2 and Class 4.
You will start paying Class 2 NI contributions if you earn over the small profits threshold.
2022-2023 tax year rates
For 2022 to 2023, the small profits threshold is £6,725. If you have exceeded the relevant threshold, Class 2 contributions are payable at a fixed weekly rate of £3.15.
For Class 4 contributions, there is a lower and an upper profit limit. For the 2022 to 2023 tax year, these limits are £11,909 and £50,270.
For profits over the lower limit you will pay Class 4 contributions at a rate of 10.25%, and for profits over the upper limit this rate is reduced to 3.25%.
Sole trader tax returns
If you have earned more than £1,000 from self-employment during the last tax year, you will need to declare this by way of a self assessment tax return after the end of the tax year that it applies to.
You can file your tax return online or by post, although the time for submitting your return will be extended by using the online system. If you are filing by post, you must submit your tax return by midnight on 31 October of the same year.
If you are filing online, this time is extended to midnight on 31 January of the following year.
If you are a filing a tax return as a sole trader for the first time, you must first register for self assessment. You will need to do this by 5 October in the second tax year that your business has been running. Once you have created an account, HMRC will post you out a 10-digit Unique Taxpayer Reference (UTR) number, usually within 10 working days. You will also receive another letter from HMRC with a code to activate your account.
If you have previously filed tax returns by post, you can create on online account using your UTR number which can be found on any tax returns or documents from HMRC. Once you have registered to use the online service you will be sent an activation code.
Once you have filed your return you will receive your tax bill, including any Class 2 and Class 4 contributions payable. If you filed online you can view the calculation when you have finished filling in your return, but before you submit it. Your final tax calculation will also be available to view in your online account around 72 hours after you have submitted your return. If you submit a paper return, HMRC will send your bill by post.
If your tax bill is more than £1,000, it will also include an additional payment towards next year’s bill, known as a payment on account.
If you made payments on account last year, you will need to deduct any payments already made towards this year’s bill to work out what you owe.
If you did not pay enough because, for example, your trading profits have increased from the previous year, you will need to make what is known as a balancing payment. Unless this is your first tax bill as a sole trader, your bill will include any tax you owe for the last tax year.
Sole trader tax payment deadline
Your sole trader tax bill for any given tax year, including any balancing payment, will be payable by 31 January of the following year. This means that for the tax year 2021-2022, you will have until 31st January 2023 to make any payment. However, HMRC must receive your cleared payment in full by midnight on that date.
If you are liable to make a payment on account to cover your estimated tax for the upcoming year, these will be payable in two instalments. The first instalment will fall due by the same deadline date for payment of your tax bill for the previous year, so by midnight on 31 January 2023. The second instalment will be payable by midnight on 31st July 2023.
Penalties for late or non-payment
If you fail to file your self assessment return in time, you will be charged a penalty of £100. There will be additional penalties if your file your return later than 3 months after it is due, amounting to as much as £1,600, depending on how long you have delayed.
If you fail to pay your tax bill on time, you may again be charged a penalty. Penalties for late payment can be as much as £750, although the penalty can be up to 100% of your tax bill if you deliberately fail to pay. You will also be charged interest on the outstanding balance.
VAT rules for sole traders
If your VAT taxable turnover is over £85,000, you must be VAT registered with HMRC. Your VAT taxable turnover is the total value of all goods and services that are not exempt from VAT.
You can also voluntarily register for VAT if your turnover is less than £85,000 and it suits your business to be VAT-registered, for example, if you sell to other VAT-registered businesses and want to reclaim the value added tax.
HMRC will send you a VAT registration certificate once you register. This will confirm your VAT number and when to submit your first VAT return and payment. It will also confirm your effective date of registration or the date you asked to register if it was voluntary. You must then charge the right amount of VAT, submit VAT returns and pay any VAT due to HMRC.
Keeping tax & accounting records
If you are a sole trader, you must keep certain financial records. These records should include evidence of all sales and income, all business expenses, as well as any grant claimed through the Self-Employment Income Support Scheme because of coronavirus. You will also need to keep records of your personal income.
You will not be required to send your records to HMRC when you submit your tax return, but you still need to keep them so you can properly calculate your profit or loss, and have these available to show HMRC if asked. You must therefore make sure your records are accurate, and retain proof of things like receipts, sale invoices and bank statements.
If you are VAT-registered, you will need to keep VAT records in addition to any records of your self-employed income and expenses, under the Making Tax Digital for VAT requirements.
Tax tips for sole traders
There are various common pitfalls when it comes to sole trader tax, from ensuring you budget for and make any payments on account to calculating the right amount of business expenses, especially where you are working from home.
Record-keeping problems can also arise where you use the same bank account for both personal and business income and outgoings.
The importance of good book-keeping, including having a separate business bank account for your sole trader finances, cannot be underestimated. In this way you can keep a clear track of any income and expenses related solely to your business.
Further, by securing expert advice well in advance of filing your self assessment return, you can feel confident that your tax bill will be correctly calculated, taking into account only deductible expenses, and plan ahead for any unexpected payments.
Sole trader tax rules FAQs
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Legal disclaimer
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law or tax 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 professional advice should be sought.
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services Limited - a Marketing & Content Agency for the Professional Services Sector.
