Introduction

As a sole trader, you will pay tax on your business profits. This is your business income less your allowable business expenses. You will pay tax on this income via a Self Assessment submission to HMRC every tax year. The personal tax year runs from the 6th April to the 5th April ever year and the tax return is due the following 31st of January.

For instance, the 20/21 personal tax year runs from the 6th April 2020 to the 5th April 2021 and the Self Assessment return will need to be filed and paid with HMRC by the 31st January 2022. When fixing this tax up, you will pay a mix of income tax and National Insurance on your business profits.

Topics covered in this article:

Registering for self assessment

Income Tax and National Insurance

Example tax calculation

Payments on account


Registering for Self Assessment

When you start out as a Sole Trader, you will need to notify HMRC that you are self employed (assuming you do not already complete a self assessment for other reasons). You'll need to register in the following circumstances:

  • You earned more than £1,000 from self employment during a tax year.

  • You need to prove you're self employed, for example to claim tax-free childcare.

  • You want to make voluntary Class 2 National Insurance contributions to help you qualify for state benefits.

If you think you have to register, you can do so by heading to this link here. Do this as soon as possible, but no later than the 5th of October after the end of the tax year you need to file for.

The system will lead you to create your Government Gateway account and enrol you for the online service. You should then receive a letter with your Unique Taxpayer Reference (UTR for short) and your activation code within two weeks to allow you to activate your online services. Then to register, simply fill in your personal details online and details for the business where prompted. HMRC provide more guidance here as well as a video explaining how to set up for self assessment once you have your activation code here.

Following registration, you will then be able to file a Self Assessment return (a.k.a. SA100) for any prior tax years that have passed. If you are on our Sole Trader Pro package, completion of your self assessment will be included within your package.


Income Tax and National Insurance

Unlike employed individuals, when you are self employed no tax will be deducted at source from your income [unless you are part of the Construction Industry Scheme (CIS)]. Therefore it is important to understand how much tax you will likely pay on your business profits. There are three main taxes you will generally pay on your self assessed profits, which we will explain below:

The tax rates that will apply to your business profits:

For the 21/22 tax year (England and Wales):

  1. National Insurance - Class 2 - If profit for the tax year exceeds £6515- then National Insurance due of £3.05 * 52. This means if your profit is over £6515 you will pay £158.60 in tax.

  2. National Insurance - Class 4 - You will pay no Class 4 National Insurance on any business profits up to £9,568.

    Business Profits between £9568 - £50,270 is then taxed at 9%. Profit >50,270 taxed at 2%.

    Class 2 and Class 4 National Insurance contributions will not be impacted by other taxable income.

    Therefore the figures that feed from your Personal Tax report for Class 2 and 4 will be accurate even without other income.

  3. Income tax - Most individuals will have a personal allowance of £12,570. This may be reduced if your taxable income from all sources exceeds £100,000. This means that if your income is below £100,000, you will pay no income tax on your first £12,500 of income. If your only income is from your self employment, the first £12,500 of your business profits will be tax free.

    After this, you then have a basic rate band of £37,700. This means your next £37,700 of income is taxed at the basic rate percentages that belong to that banding. Again if your only income is from self employment your next £37,700 of profit or less would be taxed at 20%.

    Any further profit would then fall into your higher rate band and would be taxed at 40%.

    These bandings can also be impacted positively by personal pension and gift aid contributions. Therefore if you have made these the personal tax calculator in Ember may overestimate the tax due. Contact your Ember accountant for more information how these can impact your income tax calculation.

    Unlike Class 2 and Class 4 National Insurance, this will be impacted by your other income as this will impact the banding in which your sole trade profit falls. Our personal tax report for sole traders assumes that you have no other taxable income. Therefore if you do have other taxable income please get in touch with your Ember accountant who can provide you with a personalised calculation. If you are on our free plan, you can book a call with an accountant to discuss your options here.


Example tax calculation

Client has £90,000 in Turnover and £30,000 in expenses. Assuming no other income and no other issues that could impact the calculation:

Profit from sole trader business - £60,000

Tax due

NI Class 2

as profits > £6,515 = £158.60

NI Class 4

First £9,568 - no NI due

9% due on profits between £9,568 and £50,270 = £3,663.18

2% due on £10,000 profits over £50,000 = £200

Total NI Class 4 = £3863.18

Income Tax

First £12,570 is tax free.

The profit between £12.570 and £50,270 (12570 + 37700) taxed at 20% = £7,540

Profit above £50,270 to be taxed at 40% - (60,000 - 50270) *40% = £3892

Total Income Tax = £11,432

Total Income tax and National Insurance due = £15453.78

Its worth saying with the above example, you may find yourself more efficient operating as a limited company. You can check this by using this calculator.


Payments on account

HMRC will also request that individuals also make payments on account towards the next tax year. This is normally worse in the first tax year you have to make these payments as you do not have payments on account made towards the prior tax year.

HMRC will require payments on account to be made towards the next tax year if in the current tax year:

-Your tax bill is above £1,000

and

-You had less then 80% of your tax paid at source (if you are in full time employment you will likely not have to pay POA)

If you are self employed HMRC will base your payment on account amounts on your total income tax and Class 4 National Insurance.

HMRC assumes that your tax will be the same next tax year. So the two payments on account will be 50% of your total income tax and class 4 national insurance for the prior tax year.

So take the previous example:

Income Tax for 21/22 = £11,432

Class 4 National Insurance = £3,863.18

Total = £15,295.18

HMRC will expect payment of the full amount of tax for 21/22 by the 31st January 2023.

They however will also expect an additional payment of:

1. £7,647.59 (£15,295.18 /2) also due on the 31st January 2023 as a payment in advance for the 22/23 tax year.

2. £7,647.59 due on the 31st July 2023 as a payment in advance for the 22/23 tax year.

This example assumes the individual made no payments on account towards the 21/22 tax year which would have reduced the tax due for 21/22. The first year of making payments on account will always have the biggest impact on your cash flow. In this example when the individual completes their 22/23 tax return they will have had made two payments in account in advance so this will begin to balance out.

It’s therefore imperative that you take this into account and put aside enough money to cover your tax bills when they are due. If you are late filing your tax return or paying your tax, HMRC will fine you.

If you expect your profits from your self employment to be considerably lower the following tax year or you are going into full time employment. We can put in a claim to reduce your payments on account. We can do this through your self assessment submission.

Ember's personal tax report will calculate next years payment on account's based on the information on Ember. It does not include the ability to bring in the payments on account made towards the tax year so you will need to deduct these to get an accurate idea of the amounts of tax that will be due.

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