What are my tax obligations as a sole trader?

Sole trader accounting can be a challenge. This is especially true if you’re used to working as a salaried employee and having your monthly wage arrive in your account with the relevant deductions already made.

But don’t worry – we’re here to help with our simple guide to sole trader tax obligations.

How is a sole trader taxed?

When it comes to accounting for sole traders, one of the most important things to bear in mind is that you’re not taxed at source.

This can make it seem like you’re getting paid more than you are – as it’s easy to forget about deductions.

As a sole trader, deductions you’ll need to consider include:

  • Income tax
  • National Insurance (NI)
  • VAT (if applicable)

Why can sole trader accounts be a challenge?

Unlike with a limited company – where profits must go into a designated business bank account – there are no government guidelines around keeping your finances separate as a sole trader. This means untaxed income from your sole trader enterprise is likely going into the same account you’d use for things like paying bills and getting the weekly grocery shop.

Even if you do set money aside for the taxman, it can be tempting to dip into it in an emergency.

These things considered, it’s easy to see how sole traders can end up in a pickle at the end of the tax year.

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Sole trader accounting

Understanding your tax obligations as a sole trader isn’t difficult – you just need to plan.

Bookkeeping

As a sole trader, you must keep track of everything your business makes (and spends). This record must be kept for a period of five years. This includes records of business expenditure, staff salaries (if any) and profit.

To find out how much to set aside, you’ll need to calculate the taxable profit you’ll make from your enterprise over the tax year.

Your taxable profit will be the profit made from your business that tax year, minus any allowable business expenses.

Then, consider the following deductions:

Income tax

After you’ve calculated your taxable profit, determine which tax band you’ll fall into. Remember, for those earning less than £100,000, the tax-free personal allowance for 2022/23 is £12,570. This threshold includes all taxable income from any source – including grants, pensions, property income and dividends – not just income from your sole trader enterprise.

For 2022/23, the income tax bands are as follows:

RateAnnual incomeTax rate
Basic£12,571 – £50,27020%
Higher£50,271 – £150,00040%
Additional£151,000 +45%

You can then subtract the amount of income tax you’ll pay.

If the tax year is just beginning and you’re not sure how much you’re going to make, the best thing to do is to make an estimate and deduct this percentage from every pound you receive from your sole trader business. Remember – it’s better to have set aside too much tax than too little!

National Insurance

All self-employed people must register for National Insurance Contributions (NICs). For sole traders, this means Class 2 and Class 4 NICs.

Class 2 NICs are voluntary but can help you qualify for benefits including the State Pension. For 2022/23 Class 2 NICs are £3.15 per week if you earn over £6,725 from self-employment. This is a rise from 2021/22 to temporary incorporate a Health & Social Care levy.

Class 4 NICs are calculated at 10.25% on earnings greater than £9,568 but less than £50,270 and 3.25% on earnings over £50,270.

VAT

If your business makes over £85,000 each year, you’ll need to register for VAT.

Standard rate VAT is charged at 20% on most goods and services. Much like with income tax and NIC, you’ll collect VAT on behalf of HMRC, but you’ll pay VAT quarterly rather than via your annual Self-Assessment tax return.

Calculate your total

By deducting the relevant amounts from your projected taxable profits, you should now have an idea of your tax and NI obligations as a sole trader.

Don’t forget payments on account, too. These are due by 31 June following the end of the tax year, and usually amount to half the following year’s projected profits.

You can use the Self-Assessment tool on HMRC’s website throughout the year to help you calculate your deductions. Just make sure you don’t accidentally submit your accounts before they’re complete!

How to pay yourself as a sole trader

After invoicing your customer or client for the goods or services delivered, they will usually pay you straight into your bank account using the bank details on the invoice you provided. They usually do this using bank transfer e.g. BACS, according to the payment terms stated on your invoice.

If you receive any cash for goods or services, don’t just pocket it. Instead, deposit it into your account, making a note of the corresponding sale/ job. This will make it easier to keep track of your payments for when it’s time to submit your Self-Assessment.

How to keep sole trader income and tax separate

You can do this in one of two ways.

The first is by training yourself to see every paycheque you get from your sole trader business as a pre-tax sum rather than as ready cash. This requires ongoing calculations and requires more self-discipline than the second option.

The second option is to simply open a second bank account where you can transfer money earmarked for HMRC. This could be a current account or savings account – just make sure the money is accessible in time for paying HMRC on 31 January.

If you’re just a part-time sole trader and receive earnings from an employer too, you shouldn’t need to pay tax or NI on this as your employer should have already done it for you. You’ll see this on your payslips and P60 form. However, you’ll still need to declare income from employers on your annual Self-Assessment.

tax return

The bottom line…

As a sole trader, you’ll need to make your own deductions from your pre-tax profits throughout the tax year.

Whether it’s down to unexpected one-off costs, little luxuries or even life’s essentials – it’s easy to overspend when we feel we have a ‘buffer’.

This is why it makes sense to keep profits and tax separate – just make sure any tax and NI owed is where it needs to be on 31 January – and that’s with HMRC.

If you’re looking for some extra assistance to submit your end of year accounts, or want to appoint an accountant to help with your bookkeeping, then get in touch with us today! Our specialist sole trader accounting services offer you tailored support to ensure those important tax deadlines are met.