As a sole trader, you are not an employee and do not receive a salary or wage like you would if working for someone else. So, how do you pay yourself and manage your taxes? You pay yourself through personal drawings from your business, and your Income Tax and National Insurance Contributions are calculated based on your business profits.
It’s essential to track any personal drawings you take from your business. This helps with accurate bookkeeping and calculating your profits since your taxes are based on those profits. Additionally, setting aside funds for your tax bill is crucial when it’s time to submit your annual Self-Assessment tax return.
How do I pay myself as a sole trader?
You can pay yourself as a sole trader by withdrawing money from your business bank account. It is highly recommended you use a separate bank account for your business to keep your finances separated and organised.
Be sure to record these withdrawals along with all other business income and expenses. Proper bookkeeping is key to managing your finances effectively.
Do not forget to save money to pay your tax. Keep the funds easily accessible, or consider placing them in a savings account to earn interest until it’s time to pay your tax bill.
Why should sole traders pay themselves from a business bank account?
Strong organisational skills are essential when starting your own business, particularly when it comes to managing your business banking. A well-structured approach to handling your finances from the outset can save you a lot of headaches down the road.
As a sole trader, it may seem tempting and more convenient to use a single bank account for both your personal and business transactions. However, as your business grows, this will inevitably make it harder to keep track of your finances, especially when it’s time to complete your Self Assessment tax return. For instance, was that £5.25 spent at Greggs for a business-related item, or was it just your lunch? Or maybe it was a bit of both, making it even more confusing to categorize the expense.
To avoid these types of complications and to ensure you remain compliant with HMRC, it’s critical to keep your personal and business banking separate. This means opening a dedicated business account. Not only does this simplify record-keeping and ensure that your business-related expenses are clearly identifiable, but it also helps you avoid the potential for misunderstandings or issues with tax authorities.
In fact, many banks specifically discourage the use of personal accounts for business transactions, and in some cases, doing so could violate the terms and conditions of your account. While business accounts typically come with monthly fees, they often offer introductory promotions, such as free banking for a specified period, which can help offset some of the initial costs.
Moreover, having a dedicated business account presents several benefits: it provides a clear financial separation between your personal and business finances, makes it easier to track income and expenses, and can give you access to features such as business loans, overdrafts, and more robust customer support tailored to business needs.
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How much do I need to put aside to pay my personal tax bill?
As a sole trader, you are taxed based on the profits your business generates, which you report through your annual Self Assessment tax return. Your profit is calculated by subtracting allowable business expenses from your business income. These expenses must be strictly business-related and cannot include any personal costs.
Naturally, the more profit you report, the higher your earnings and tax obligation will be. We recommend that you reserve the following amounts from your regular income to cover your Income Tax and National Insurance liabilities each year.
| Annual Profits | Amount to set aside for tax |
|---|---|
| Up to £50,000 | £12,500 |
| Up to £100,000 | £40,000 |
| Between £100,000 and £150,000 | £65,000 |
| Over £150,000 | £67,500 or more |
Is all the money from the business mine?
As a sole trader, the law treats you and your business as one entity. The income you earn is yours to keep, but you’re also responsible for covering any expenses, including your personal tax obligations on the business’s profits. This can be tricky to manage, especially when there’s a delay between receiving payments from your customers and paying your personal tax.
If you have income from both employment and self-employment, it is essential to report all of this on your annual Self Assessment tax return. While your employer will already have deducted the relevant income tax and National Insurance contributions through the Pay As You Earn (PAYE) system, you still need to include this income on your Self Assessment to ensure everything is correctly accounted for.
To find the details of your income from employment, refer to your P60 form. This form is provided by your employer at the end of the tax year and will show your total earnings and the amount of income tax and National Insurance contributions that have been deducted from your salary. You will need to include the income tax and National Insurance contributions already deducted by your employer when completing your Self Assessment. The HM Revenue and Customs (HMRC) will then use this information to calculate if you owe any additional tax or National Insurance contributions based on your self-employment income.
What if I also have earnings from rental or dividends?
If you are also receiving income from other sources, such as dividends from a company or rental income from property, you are required to report these as well. All forms of income, whether from self-employment, dividends, or property, must be disclosed on your Self Assessment tax return. HMRC will take this information into account and determine the amount of tax owed on these additional earnings.
It is important to include all sources of income to ensure that you are paying the correct amount of tax. If you need more detailed guidance or examples of how to report various income sources, get in touch with us. Our team of qualified accountants will provide further clarity on the tax obligations for those with multiple income streams.
Is my profit reported to HMRC and how do I pay?
Your profits are reported to HMRC each tax year through your Self Assessment Tax Return, which is the primary way for sole traders to report their income and expenses. When you submit your Self Assessment, HMRC will calculate your income tax and National Insurance Contributions (NICs) based on your reported earnings, and this will determine the total amount due for your final tax bill. It’s important to remember that your Self Assessment must be filed, and any taxes you owe must be paid before the 31st of January each year. If you fail to meet this deadline, HMRC will issue a penalty, starting at £100, even if the tax due is paid within a few days after the deadline.
If your tax liability for the year exceeds £1,000, HMRC requires you to make what’s known as a “Payment on Account.” This system is designed to ensure that tax is paid more regularly, rather than waiting for the final bill at the end of the year. The Payment on Account is split into two equal instalments: the first is due by the 31st of January, and the second must be made by the 31st of July each year. These payments go towards your next Self Assessment, reducing the amount you’ll owe when you submit your return the following year.
In some cases, if you expect your income to be lower in the upcoming year, or if you anticipate a reduction in your sole trader profits, you may not need to make the full Payment on Account. In such instances, you can contact HMRC or speak with your accountant to request a reduction in the amount you’re required to pay in advance. This can help ensure that you’re not overpaying and can ease cash flow if your profits are expected to decrease.
While filing your Self Assessment as a sole trader can be simpler compared to running a limited company, keeping track of your income, expenses, and tax obligations can still be time-consuming and complex. Using online accounting software can simplify the process significantly, as it allows you to track your income and expenses in real-time, manage your Self Assessment, and submit your tax return directly to HMRC. With services like Lera accountancy, you’ll also benefit from unlimited support from dedicated client managers who can assist you with any questions or concerns, as well as expert accounting advice to ensure you’re compliant with tax laws and optimally managing your finances. You can learn more about our tailored accounting packages for sole traders and how they can make tax season much easier.
Do I pay National Insurance?
The National Insurance contributions on your income from your employer will remain unchanged, but there will be some differences for the income derived from self-employed profits.
If your self-employed annual profits exceed £6,725, you will not need to pay Class 2 National Insurance Contributions. However, if your annual self-employed profits surpass £12,570, you’ll be required to pay Class 4 contributions. For the 2024 to 2025 tax year, the rates are as follows:
- 6% on profits between £12,570 and £50,270
- 2% on profits exceeding £50,270
Class 4 National Insurance contributions, like your Income Tax, will be calculated based on your Self Assessment tax return.
Don’t forget that you’ll also be responsible for Class 1 National Insurance contributions if you have paid employment, with deductions made by your employer. For further details, visit the gov.uk website.
What about expenses?
Registering as self-employed and operating as a sole trader offers a major benefit: you can offset your business expenses against your income, meaning you’re only taxed on the profits your business generates, not the total income. This allows you to reduce your taxable income by deducting eligible expenses, which could include things like office supplies, equipment, business-related travel, and more.
A similar tax advantage exists for limited companies. As mentioned earlier, if you’re working as a director or employee of your limited company, your salary is considered an allowable business expense. This means your salary can be deducted from the company’s income, thus lowering the overall taxable profits of the business and reducing the amount of Corporation Tax you owe. In addition to your salary, there are numerous other business-related expenses that are deductible, such as rent for office space, utilities, insurance, software subscriptions, business travel, and professional fees.
However, the process of determining what constitutes an “allowable” expense and how to properly claim these expenses can be quite intricate. For instance, some expenses may only be partially deductible depending on their usage, and the tax authorities have specific guidelines on what qualifies. This is why it’s crucial to understand the rules around allowable expenses and ensure that you’re claiming them correctly to avoid any potential issues with the tax authorities.
To avoid confusion, we recommend reviewing detailed articles about expenses for sole traders and limited companies. These resources provide comprehensive explanations of which expenses are deductible and offer practical guidance on how to claim them. One important point to remember is the “wholly and exclusively” rule, which states that any expense you claim must be incurred solely for the purpose of your business. This means that if an expense has a personal element, only the portion related to your business is claimable. Understanding this rule is essential to ensure that you only claim legitimate business expenses and stay compliant with tax regulations.
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