As a sole trader, you’re not directly employed and you don’t receive a salary or wage in the traditional sense. So how do you pay yourself as a sole trader and then pay any tax due? You pay yourself based on personal drawings from the business, and you pay Income Tax and National Insurance Contributions based on the profits your business makes.
So, it’s important to keep a record of any personal drawings you take from the business to pay yourself. This helps you to keep on top of your bookkeeping and helps when calculating your profits, as eventually, you pay tax on your profits. You’ll also need to put some money aside to pay your tax bill when you submit your annual Self Assessment.
As a sole trader, how do I pay myself from my business?
You can simply take money from your business account to pay yourself as a sole trader. We strongly recommend that you use a separate business bank account for your sole trader finances.
You need to make sure that you keep a record of these drawings, along with any other incomings and outgoings. We’ve got an article about the importance of good bookkeeping with some handy hints and tips.
Don’t forget though, you need to put some money aside to pay any tax you owe. The money should be easily accessible, but you could always put it into a savings account to earn interest until you pay the taxman.
Why you should get a business bank account
Strong organisational skills are vital when you’re setting up your own business, and it’s particularly important to apply this to your business banking.
Of course, if you’re a sole trader, it may appear easier and more convenient to use one bank account for work and personal expenses - but as you get busier, it’ll definitely become more difficult to decipher all of your bank statements when it comes to Self Assessment time. Was that £3.79 in WHSmith a business expense, or your lunch? Or perhaps both?
To avoid confusing matters, and to avoid possible problems with HMRC, it’s absolutely essential to make sure that you keep your personal and business banking separate, and to do that you’ll usually need a dedicated bank account for your business.
Many banks don’t want to let you use a personal account for business purposes - indeed, it may be against the terms and conditions of your personal account. Most business bank accounts come with monthly fees, but also offer introductory offers such as free banking for a set amount of time.
For more advice, check out our article Opening a business bank account – How and why you should do it.
How much should I put aside to pay my tax as a Sole Trader?
As a sole trader, you’re taxed on the profits that your business makes through your annual Self Assessment tax return. Essentially, your profit is the income that your business receives, minus the allowable sole trader business expenses incurred.
These expenses must be purely for business, and must not include any personal expenditure.
Obviously, the higher the amount of profit you report, the more you’ll earn and the greater your tax liability will be. We recommend you set aside the following amounts from your regular drawings to settle your Income Tax and National Insurance liabilities each year:
Isn’t all the money in the business mine?
When you’re a sole trader, as far as the law is concerned, there’s no legal difference between you and your business. You receive the income and pay the expenses, including the tax liability which you must pay as an individual. This can be tricky to manage because there can be a time lag between receiving income from your customers and paying the personal tax you owe on your business profit. We’ve got an article that explains the taxes you may need to pay as a small business.
What happens if I also have earnings from employment or dividends?
If you have income from employment as well as your self-employed income, you’ll need to declare it on your annual Self Assessment tax return. Your employer should have deducted the income tax and National Insurance due through the Pay As You Earn (PAYE) scheme.
You can see this information on Form P60, which your employer must give you at the end of the tax year. You include the income tax deducted by your employer on your Self Assessment for the same tax year and HMRC will calculate any additional income tax or Self-Employed National Insurance due.
Similarly, if you receive any dividends from a company or other income (such as from property), you must include these on your Self Assessment and HMRC will calculate the tax you owe.
Our Knowledge article “Freelancing on the side: what tax do I pay?” has further details including some worked examples.
How is my profit reported to HMRC and how do I pay?
Your profits are reported to HMRC each tax year via your Self Assessment Tax Return. Your income tax and NICs (National Insurance Contributions) calculation will highlight how much you’ll be paying on your final tax bill. Your Self Assessment must be filed and all taxes you owe must be paid before the 31st January each year. Otherwise, HMRC will fine you, with penalties starting from £100.
If your tax bill is more than £1,000 for the year, you’ll be required to make a Payment on Account. This is HMRC’s way of ensuring tax is paid regularly and it goes towards your next Self Assessment. There are two payments made towards the Payment on Account: the first must be made by 31st January and the second payment is due on or before the 31st July each year.
If you believe that you won’t have as much sole trade profit in the next tax year, you should speak to HMRC (or your accountant if you’re with Crunch) and you may be able to reduce your Payment on Account to HMRC.
Even though things are slightly simpler for a sole trader than for a limited company, you might still find it’s easier to use online accounting software to keep track of all this and prepare and file your Self Assessment. With Crunch, you’ll also get unlimited support from a team of client managers and advice from expert accountants. Find out more about our accounting for sole traders packages.
What about National Insurance?
The National Insurance you pay on your income from your employer won’t change, but it’ll be a bit different for your income from self-employed profits. Firstly, if your self-employed profits exceed £12,570, you’ll have to pay a flat rate of £3.45 per week. This is called Class 2 National Insurance.
You usually pay Class 1 National Insurance through PAYE via your employer, but Class 2 is paid directly to HMRC through a direct debit, which you can register for online at Gov.uk. We’ve got an article with all the information you need on how to register as self-employed, including who you need to contact and when.
If you’re doing well, you may also have to pay Class 4 National Insurance. This is charged at 9% for all self-employed profits between £12,570 and £50,270, and at 2% for all profits greater than £50,270.
Just like your Income Tax, Class 4 National Insurance contributions will be worked out on your Self Assessment tax return. Let’s use the same figures from our previous example to demonstrate how this all works:
Remember, you’ll have your Class 1 National Insurance to pay too, through deductions made by your employer for your paid employment, you can find details on the gov.uk website.
What about expenses?
One of the main benefits of registering as self-employed as a sole trader is that you get to offset your business expenses against your income. You’re only taxed on your self-employed profits.
The situation is similar for limited companies. As mentioned earlier, your salary when operating as a limited company is an allowable business expense. There are many other business expenses that you can claim which have the benefit of reducing your company profits and therefore the amount of Corporation Tax your company needs to pay.
What exactly is considered to be an allowable expense and how to claim it is a complicated affair, so we won’t get into that here. Instead, take a look at our limited company or sole trader expenses explainer articles, and bear in mind the “wholly and exclusively” rule (i.e. anything you claim as a business expenses).
Need help getting started?
We're always looking for ways to support ambitious self-employed and sole trader professionals, and to get you started we've got lots of free resources to explore, including articles and tax calculators. Our team of experts here at Crunch consist of specialist advisors who can guide you through our accounting software to qualified accountants who are available to answer your financial questions through our Ask an Accountant service, file your Self Assessment tax returns, and get your bookkeeping up-to-date. Get in touch with us today or sign-up online.