Sole Trader Tax Guide
Being a sole trader means that youāre your own boss, which means keeping all your hard-earned money (after tax of course!) Itās the same as being self-employedāboth allow you to manage your own deadlines and choose the clients you want to work with. This is true across all industries too, whether youāre an independent hairdresser or ad hoc consultant for small businesses.
But most sole traders go from using the UK PAYE tax system as employees to completing Self Assessment tax returns without quite knowing how. And this means they have to trawl HM Revenue & Customsā (HMRC) site for answers while their scary deadlines loom ever closer. But not anymoreā¦ Our ultimate guide to sole trader tax is here. It helps you learn everything you need to know about UK taxes as a sole trader, and it does it as quickly as possible so that you can get back to innovating in the salon, helping businesses succeed, or focusing more energy wherever your passion lies.
Here’s What We’ll Cover:
What Are the Advantages and Disadvantages of Being a Sole Trader?
The main benefit that sole traders often shout about? Freedom. Working for yourself, picking your hours, and deciding which projects you work onā¦ Thereās a lot to love about being a sole trader. Another big selling point is having complete control over your finances. After all, payments are made directly to you now, and you can use those profits however you wantāwhether thatās investing in your craft or a much-needed holiday. Whatās more, you can even claim tax relief on a number of your business-related costs, like travel.
Of course, the price of all this freedom is that youāre now in charge of declaring your income to HMRC through a Self Assessment tax return. Itās a pretty boring prospect, but itās necessary. Reporting how much youāve earned (and any expenses you want to claim) as a sole trader enables HMRC to tax you on your profits. Youāll then pay the resulting tax bill directly to HMRC, instead of it automatically coming out of your wages. If youāre late submitting your tax return or paying your tax bill, you could face penalties and interest chargesāso it really does pay to be prepared.
Have a limited company?
Things are slightly different when you set up a limited company. Here, you create a separate legal entity with yourself as a director. Your finances and the finances of your company are separate, and you effectively pay yourself a salary and dividends. A limited company has some tax advantages (Corporation Tax is lower than higher rates of Income Tax, for example, and there are more options in terms of tax relief), but there can be some pitfalls too, such as managing and accounting for limited company expenses. Weād always suggest that you seek the advice of an accountant if youāre thinking about going down this route.
How Do I Register As a Sole Trader?
Settled on being a sole trader? Alright. Now you need to let HMRC know. You do this by registering for Self Assessment on their website before the 5th October in your businessā second tax year. So, if you started working as a sole trader in July 2020, thatās the 5th October 2021. If youāve not registered before, youāll need two things: A Unique Taxpayer Reference (UTR) number (so you can file a tax return to HMRC) and a Government Gateway ID (to log on to HMRCās online service). These can take up to 10 days to arrive, so be sure to do this way in advance of any deadlines.
When Do I Need to File My Self Assessment Tax Return and Pay My Taxes?
All sole traders need to file their Self Assessment tax return online by the 31st January. So, for the 2019/20 tax year ending 5th April 2020, the deadline for filing your 2019/20 tax return online is the 31st January 2021. If you prefer to file by paper, youāll need to submit your Self Assessment a little earlierāby 31st October, so 31st October for the 2019/20 tax year.
The 31st January is also the deadline for paying any tax you owe (known as a balancing payment) and possibly your first payment on account (an advance payment towards your next tax bill). You may also need to make a second payment on account on 31st Julyāeach payment is half your previous yearās tax bill and helps to spread the cost.
Letās say that you have a Ā£4,000 tax bill for the 2019/20 tax year. The full amount of this would be due on the 31st January 2021. HMRC assumes youāll owe a similar amount for the following tax year, so will also require your first payment on account of Ā£2,000 (thatās 50% of Ā£4,000) on the same day. This brings the total amount due to Ā£6,000, with a further Ā£2,000 to be paid as a second payment on account on 31st July 2021.
As both your balancing payment and first payment on account are due on the same day as your Self Assessment tax return, weād always recommend filing early to give yourself an idea of how much youāll ultimately owe. Why? Because knowing how much tax you owe allows you to manage your cash flow ahead of time, and gives you an easier, more confident start to the new year. And we all want that, right?
Tax software
FreshBooks partner, GoSimpleTax, can help here. You can use their platform to input your income and expenditure throughout the tax year, and itāll use this to automatically calculate your tax bill in real-time. That means no surprises come deadline day. Users can then file their tax return directly to HMRC through the software too.
How Do I Fill Out a Tax Return and Pay Tax As a Sole Trader?
Thankfully, as a sole trader, you arenāt taxed on all of your income. All UK taxpayers receive a tax-free Personal Allowance. As of 2020/21, your Personal Allowance is Ā£12,500āthis is applied to your total earnings when you submit your Self Assessment tax return. If your total taxable income (including any other forms of income such as that from employment or a property you let out) is less than your Personal Allowance, then you wonāt pay any tax. Simple.
Again, you only pay tax after youāve filed your Self Assessment tax return. And, you use this to declare your self-employed expenses and income, along with any additional income you had during the year. Remember to include all your income on your tax return, even if youāve already paid tax on it. The amount of tax you then pay is calculated based on your total income for the year. Hereās what the 2020/21 tax brackets look like:
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Tax Bracket | Taxable Income | Tax Rate |
Personal Allowance | Up to Ā£12,500 | 0% |
Basic rate | Ā£12,501 to Ā£50,000 | 20% |
Higher rate | Ā£50,001 to Ā£150,000 | 40% |
Additional rate | Over Ā£150,000 | 45% |
Filling out your Self Assessment tax return shouldnāt be daunting. As a sole trader, youāll fill in two forms at first: The SA100 (main tax return) and either the SA103S (the form for self-employment if your annual turnover was below the VAT threshold (Ā£85,000) for the given tax year) or the SA103F (the form for self-employment if your annual turnover was above the VAT threshold). There are other forms for other sources of income, such as employment (SA102), UK property income (SA105), foreign income or gains (SA106) and business partnerships (SA104S and SA104F).
Once youāve completed all the forms that apply to you, you need to submit them to HMRC before the deadline. This can be done via HMRCās online service, through tax return software, or by posting your paper forms. Navigating the government portal can be a bit of a headache, so be sure to give yourself enough time to familiarise yourself with itāthereās nothing worse than a last-minute rush! Youāll then need to pay your tax through the HMRC portal, by post, or by bank transfer.
What Expenses Can I Claim As a Sole Trader?
You might be able to reduce this tax bill by using your Self Assessment tax return to claim your business-related expenditures. Some expenses are relevant to almost every self-employed person. Stationery and home computers are two key examples. If you take notes of appointments, log finances or carry out Zoom calls, you can buy the related home office supplies (provided theyāre used purely for business purposes) and claim tax relief on them. More money in the bank? Yes please.
Train tickets, petrol and other vehicle costs are examples of common expenses. Even a portion of your utility bills can be claimed if you work at home. All you need to do is work out the percentage of your heating and electricity bill thatās used while homeworking. HMRC has a big list of self-employed expensesāso add them as a bookmark and you can always refer back to it. To make life easier for the sole trader, HMRC also has some simplified ways of claiming expenses for using your car and working from home.
Sole trade expenses also tend to be more sector-specific. Say, for example, that youāre a personal trainerāyou could claim on your gym membership or any advertising costs for your classes. Likewise, for beauticians, equipment costs and the rent you pay for your studio can both be claimed on as theyāre purchased purely for the purpose of your business. But no matter what you claim you can easily track all expenses and receipts in FreshBooks.
Whatever you do, donāt forget to keep evidence of the expenses youāre claiming for. While you donāt have to submit receipts along with your Self Assessment, itās possible that HMRC will request proof of your deductions. For this reason, all invoices, bank statements and receipts should be kept safe and in good condition in case of an investigation.
What If Iām Investigated by HMRC?
As HMRC has the right to check your tax affairs at any point in time, itās vital you stay on top of things. But they wonāt try and catch you out or keep you guessing; when they announce their investigation through either a letter or some other official notice, theyāll say exactly what theyāre searching for.
There are three types of investigation: Full enquiry, aspect enquiry and random check. The first involves HMRC reviewing all your business records because they think thereās a significant risk of error in your tax. The second relates to inconsistencies in a particular part of your records (this is the most common). Finally, a random check is as the name suggests and is usually as extensive as an aspect enquiry.
Unless they believe youāve been deliberately making errors on your taxes, HMRC typically investigates records of up to six years old. Thatās why you should make sure that you have evidence for all the tax relief youāve claimed over the last five years. This includes all those receipts that get stuffed in your wallet or drawer and can tend to fade or get misplaced (you know the ones we mean), so find somewhere safe to store them, or leave them with an accountant. The alternative, of course, is to invest in Self Assessment software that allows you to upload images of your receipts and store them in the cloud (i.e., track expense receipts in software like FreshBooks).
If you do like the look of Self Assessment software, you may also find it easier to meet your deadlines. Many providers will notify you of upcoming submission dates and encourage you to file earlyāmeaning youāre more likely to avoid a late-filing penalty and may be less likely to be investigated by HMRC in the first place.
How Can FreshBooks Help Sole Traders?
At FreshBooks, our role is to help freelancers and self-employed professionals keep tabs on the health of their finances. By using our helpful tools and in-depth support, you can easily monitor your cash flow and grow sustainably.
As well as this blog on being a sole trader, we also have a whole host of resources on UK tax law. From guides on paying the tax you owe to recognising allowable expenses, get the knowledge you need to stay on the right side of the HMRC.
Whatās more, whichever stage in the business journey youāre at, FreshBooks also has in-house customer support. Whether you want to create and send your first invoice to a client or improve your cash flow with easy Direct Debit online payments, know that youāre not alone in thisāweāre here to help. Get in touch to take the next step towards evolving your accounting.
For all things Self Assessment, turn to the experts at GoSimpleTax. Accounting Excellence award winners, their software makes completing a Self Assessment tax return straightforward. You can start using it to input your income and expenditure for free tooāyou only need to upgrade your account when youāre ready to submit your tax return directly to HMRC. Sign up for their trial today.
More Useful Resources
- Allowable Expenses & Disallowable Expenses
- Working from Home Tax Relief
- Self Employed Expenses
- Marriage Allowance
- Tax On Rental Income
- How Is Corporation Tax Calculated
- How to Reduce Corporation Tax
- Limited Company Expenses
- Business Asset Disposal Relief
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