Sole Trader Tax Guide

Confused by sole trader tax? Wondering how to cut through the jargon and find some simple, straight-forward answers? Then you’ve come to the right place.

In this guide, I’ll explain the basic concepts about sole trader taxes so you know exactly what you need to do and when.

I’ll also share some tips, shortcuts and additional information to make your taxes easier to manage and reduce your tax bill because I know it’s hard enough managing your clients and finding work without the burden of the taxman!

When to Register as a Sole Trader

You can earn a side income of £1,000 without letting HMRC know and paying tax. This is known as the trading income allowance.

But once your income (not profit) goes over this threshold you should register as a sole trader with HMRC.

You may also want to register even though you have an income of less than £1,000 but have made a loss due to paying business expenses, so you can record a trading loss that you can use against your future profits to save tax in future tax years.

Whatever your reason for registering, you’ll need to let HMRC know by the 5th October following the end of the tax year you started working for yourself.

A tax year runs from 6 April to 5 April each year.

So if you started working for yourself on 1 January 2020, you’ll need to register as a sole trade by 5 October 2020.

There is an automatic penalty of £100 for failing to register, so I would recommend you register sooner rather than later so you don’t forget.

Want to Register? Follow this guide How to Register as a Sole Trader

What Tax Do Your Pay as a Sole Trader?

Once registered with HMRC, you’ll need to start handling your own taxes. When you work for yourself, you’ll need to pay the following:

  • Income tax
  • Class 2 and Class 4 national insurance

The amount of each you pay will depend on how much profit you make(that’s all your business income less allowable expenses).

How Much Tax Do You Pay?

These are the current income tax and national insurance rates along with the tax-free thresholds:

 2020/20212019/2020
Personal Allowance£12,500£12,500
Basic rate 20%£12,501 to £50,000£12,501 to £50,000
Higher rate 40%£50,001 and £150,000£50,001 and £150,000
Additional rate 45%over £150,000over £150,000
 2020/2021
Class 2 National Insurance£3.05 per week on profits over £6,475 per year
Class 4 National Insurance9% on profits between £9,501 and £50,000
2% on profits over £50,000

That means you can earn up to £12,500 before paying tax, £6,475 and £9,500 before paying Class 2 and Class 4 national insurance respectively.

When it comes to income tax, however, the amount you pay is based on all your earnings. So say you are employed and work for yourself, you’ll need to combine both your income before working out how much sole trader tax you’ll pay.

Example

Let’s say that I am a full-time bookkeeper registered as a sole trader for the tax year 2020/2021 (6 April 2020 to 5 April 2021), with an income of £50,000 and I want to claim business expenses of £10,000.

My business profit is £40,000 (£50,000 – £10,000) and I have no other forms of income. That means I’ll pay the following:

  • Income tax of £5,500 (£40,000 – £12,500 x 20%)
  • Class 2 national insurance of £158.60 (£3.05 x 52 weeks)
  • Class 4 national insurance of £3,600 (£40,000 x 9%)

If I had other forms of income, I’d need to pay more income tax and will calculate my sole trader tax based on my combined income. I’d also receive credit for any tax I paid in my employment.

What Can a Sole Trader Claim Against Taxes?

The great thing about working for yourself is that you get to deduct expenses that you pay for in your business against your income before you work out your taxes.

HMRC sets out what you can and can’t claim for against your sole trader tax – these are known as Allowable and Disallowable Expenses.

Common allowable expenses are:

  • Website
  • Hosting
  • Email
  • Equipment like laptops
  • Travel

Common disallowable expenses are:

I’ve put together a guide to allowable and disallowable expenses, along with a cheat sheet that you can download and keep.

Sole Trader Tax-Free Allowances and Reliefs

The main tax-free allowances are the £1,000 Trading Income allowance as well as personal allowance which entitles everyone in the UK to earn £12,500 tax-free for 2020/2021.

Other HMRC income tax allowances and reliefs, aside for the trading and personal allowance that you should be looking out for are:

  • Capital Allowances
  • Mileage Allowance
  • Simplified Expenses
  • Trading Losses
  • Marriage Allowance

Read more about these tax reliefs and more in this Guide to Income Tax Allowances and Reliefs.

When is your Tax Due?

You pay your taxes twice a year to HMRC – by the 31 January and 31 July each year (although the 31 July 2020 payment requirement has been cancelled as part of the coronavirus financial support offered by the Government).

By the 31 January each year, you’ll need to file your tax return and pay any tax you owe as well as making a payment towards your next year’s tax bill. This is known as a payment on account and it’s calculated as 50% of your current tax bill.

By the 31 July each year you’ll need to make another advance payment towards your next tax bill, again of 50% of your previous tax bill.

When you do your tax return, your advance payments will be taken into account and you’ll pay the difference. But it does mean that you pay a 50% more tax the first time you put in your HMRC tax return.

How to File Taxes as a Sole Trader

Filing taxes in the UK means submitting a self-assessment tax return, usually online once a year by the 31 January.

One tax return covers one tax year. So your tax return for 2019/2020 is due by with HMRC by 31 January 2021 and will contain details of your income and sole trader tax for the period 6 April 2019 to 5 April 2020.

Do You Pay VAT as a Sole Trader?

You have to register for VAT once your business turnover goes over £85,000. Once registered you’ll need to charge VAT and can reclaim any VAT you have paid.

If your income is below the registration threshold you do not have to pay VAT.

Do I Pay Corporation Tax as a Sole Trader?

No sole traders do not pay corporation tax, that is a tax that is paid by Limited Companies only. You’ll pay income tax and national insurance instead,

Sole Trader or Limited Company?

How to Save Tax as a Sole Trader

The easiest (and more overlooked) way to save tax is by claiming all the expenses you are entitled to. That means keeping your bookkeeping and accounting up to date so you don’t miss out or forget about any expenses.

I’ve also put together a list of tax tips for sole traders that will help you to reduce your tax bill.


New Here? Learn how to set up the financial side of your business with these guides and resources:

Anita Forrest
About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek, money nerd and creator of www.goselfemployed.co - the UK small business finance blog for the self-employed community. Here she shares simple, straight-forward guides to make self-employment topics like taxes, bookkeeping and banking easy to understand.