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There are several ways to get started when starting a business. You can operate as a sole trader, form a partnership, or set up a limited company. Among these, being a sole trader is the simplest because it involves less paperwork and fewer formalities.
Taxes You Must Pay
If you choose to run a business as a sole trader, you are classified as self-employed for tax purposes. This means any profit you make is part of your personal taxable income. If your income exceeds your tax-free allowances, you’ll need to pay income tax on your profits. Unlike a company, your business tax is calculated together with your overall personal tax liability. Also, if your profits are high enough, you may need to pay Class 4 National Insurance contributions.
Registering as a Sole Trader
You only need to inform HMRC about your self-employment income if it exceeds £1,000 in a tax year before deducting expenses. This threshold is known as the trading allowance and applies across all self-employments combined, not per business. If your income exceeds this limit, you must register for Self Assessment. Registration can be completed online and must be done by 5 October following the end of the tax year when the liability first arose.
National Insurance
National Insurance depends on your profits:
- Above £12,570: You pay Class 4 National Insurance at 6% on profits up to £50,270 and 2% on profits above that. This also earns you a qualifying year for your state pension.
- Between £6,725 and £12,570: No payment is required, but you get a National Insurance credit, which counts toward your state pension.
- Below £6,725: You won’t receive credit but can opt to pay Class 2 contributions voluntarily at £3.45 per week to protect your pension entitlement.
Keeping Records
To determine your profit, you’ll need to keep clear records of income and expenses. The default method for calculating profit is the cash basis, which considers only cash in and out. Instead of claiming actual expenses, you can deduct the £1,000 trading allowance if it is more beneficial—usually when expenses are less than £1,000.
Paying Tax and National Insurance
As a sole trader, you pay tax and Class 4 National Insurance under Self Assessment. The bill for each tax year must be settled by 31 January after the tax year ends. For instance, your 2024/25 tax bill is due by 31 January 2026.
If your total bill for the previous year exceeds £1,000, you’ll also need to make account payments. These are advance payments split into two instalments: 50% is due on 31 January during the tax year, and the remaining 50% is due by 31 July after the tax year ends. Any leftover balance is payable the following 31 January.
Managing Payments
It’s wise to save a portion of your income each month for tax payments so you’re not caught off guard. Alternatively, you can arrange a budget payment plan with HMRC to spread the cost over the year.
For further advice or information, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.
No, if your income from self-employment is below £1,000 in a tax year, you don’t need to register. However, you may still choose to register if you want to build a record for state pension purposes or claim certain tax reliefs.
The trading allowance is a tax-free threshold of £1,000 for self-employment income. If your income is below this, you don’t need to declare it to HMRC. If your income exceeds £1,000, you can either deduct the trading allowance or claim actual expenses—whichever is more beneficial.
National Insurance contributions are crucial for building up your state pension entitlement. If your profits are above £12,570, your payments ensure a ‘qualifying year ‘, which is a year where you’ve paid enough National Insurance to count towards your state pension. For profits between £6,725 and £12,570, you automatically receive a credit. If your profits are lower, you can voluntarily pay Class 2 contributions to safeguard your pension.
Self-assessment payments are due by 31 January after the tax year ends. If your liability exceeds £1,000, you’ll make advance payments on 31 January and 31 July. To prepare, save a portion of your income monthly or set up a budget plan with HMRC.