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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.
If you’re a limited company director the situation is different and you should read our article “How much should I take as a salary?”
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. It should be easily accessible, but you could always put it into a savings account to earn interest until you pay it to the taxman.
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:
|Profits per annum||% set aside for tax|
|up to £50,000||25%|
|up to £100,000||40%|
|between £100,000 and £150,000||45%|
We explain more in our sole trader webinar and Q&A at the bottom of this article.
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.
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.
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 a 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.
Join our expert Ben Schaefer for a jargon-free explanation of what taxes you’re expected to pay as a sole trader.
Q: If you have a small side business (making, say a few hundred pounds a month) at what point do you need to inform HMRC that you setting up as a sole trader to declare additional income?
We’ve got an article about freelancing on the side that explains it all. In short, you should register as self-employed as soon as you receive any income that is not taxed at source – but you may not need to pay any tax on that sole trader income until you earn over £1,000 in a single tax year. Any tax or National Insurance due would be calculated and paid through your annual Self Assessment.
Q: Can you go over the annual dates that Self Assessment needs to be filed by each year? And, is there help to complete a Self Assessment form?
Yes of course, our article “Do I have to complete a Self Assessment?”covers it all.
We’ve got an article and a downloadable business guide on how to complete your Self Assessment. This is one of the reasons an online accounting system with apps for recording mileage, expenses and importing bank statements and transactions can be so helpful.
The Crunch Sole Trader Accountancy service has all this and even prepares and submits your Self Assessment for you from just £29.50 +VAT per month.
Q: If your sole trader profits don’t exceed £6,365 then do you still pay any National Insurance (NI) on your sole trader profit, or if I have understood correctly, there is no NI to take off this portion in that situation?
As above, you need to make sure you’re registered as self-employed and complete an annual Self Assessment; HMRC will then let you know what Income Tax and National Insurance you need to pay.
Our article on self-employed National Insurance also explains how much and when you pay NI. If your sole trader profits are below the Small Profits Threshold (£8,365 in 2019/20) then you will not pay any self-employed NI.
Q: I thought Class 2 was part of the yearly Self Assessment as HMRC got rid of the monthly DD (or quarterly/half-yearly)?
Class 2 National Insurance is calculated weekly but is paid as part of your annual Self Assessment – you do not need to set up a monthly Direct Debit to pay Class 2 NI contributions separately.
Q: If you are completing a Self Assessment to declare additional income from a rental property, are you classed the same as a sole trader with the additional NI class or not?
No, if you are only declaring rental income this is not classed as sole trader income, so you will not pay self-employed National Insurance on this income.
Q: If at some point you want to change your business name, how do you do this? Is it complicated?
It’s fairly simple if you’re a sole trader. You just need to update any templates you use for invoices etc. and let your clients know. You may need to update websites or any business listings too. There are rules about the name you choose for your business – we cover these in our ‘What is a sole trader?” article.
If you decided to work through a limited company then changing the name of your business is a bit more complicated, as you need to let Companies House and HMRC know. We cover all this and more in our “Choosing a great company name ” article.
Q: Do you need any insurance as a graphic design sole trader freelancer?
Ideally, yes. Small Business Insurance can protect you, your business, or your clients from the unexpected. Even if you don’t work in-house or have any employees, Professional Indemnity Insurance offers protection for your business against a customer suing you for a financial loss that they believe you caused through negligent advice and services.
Q: If you have started your freelance by using one personal account and then moved the business finances across to a business account thereafter, how do you list this in your tax accounts?
Ideally, you should have at least been using a separate personal account for the business income before you set up a business bank account. Either way, you need to declare any income as a sole trader and have receipts for any expenses to wish to claim as a sole trader. You’ll need to keep copies of your invoices, receipts and any relevant bank or credit card statements (personal or business) for up to six years.
Q: I’m employed part-time 3 days per week, in the higher tax bracket, and am already doing Self Assessments. I started 1 day per week contract work as a sole trader with limited revenue. Should I still be putting 25% aside to cover tax from sole trader work, or will it end up being taxed at the same rate as my PT employment?
A: In this situation, you should probably put aside 40% to cover your sole trader income, as you will already have used up your personal allowance and the Basic rate band.
Q: If I work as a consultant from home, can I offset any business expenses as a sole trader (like electricity bills etc)?
The simple answer is yes, there are a number of expenses you can claim when working from home.
We’ve got an article about working from home and the expenses you can claim. It’s slightly complicated, and it depends on whether you’re set up as a limited company or as a sole trader. As a sole trader, you also have a choice over how you claim your expenses, either using “simplified expenses” to claim a flat rate, or claiming a proportion of your household bills.
Q: Can your fees be charged as expenses?
Yes, business accountancy fees can be claimed as an allowable expense.
Q: How do I come onboard as a client?
You can just give us a call on 0333 311 8000 to speak to one of our friendly advisors, or you can arrange a callback. The short call will help you to decide on the right package for you, make an initial payment, and then we can have you up and running with Crunch in as little as a few hours.
Q: How do I apply for a Crunch mortgage?
Just call our Crunch Mortgage advisors on 03300371671 or arrange a callback and our Crunch mortgage advisers will be able to help you find the right mortgage for you.
Q: Can Crunch help me to determine whether I should operate as a limited company or a sole trader?
A: Absolutely! Our advisors are here to assist with making these sorts of decisions and will listen to your circumstances so that we’re able to provide you with tailored advice that’s suitable for you and your situation. We’ve also got a great article to help you decide whether operating as a sole trader or limited company is best for you.
Q: How do I set up a limited company if I decide to become one?
A: It’s really simple, and you can either do it yourself in minutes on our Crunch Formations site, or we can do it for you if you become a Crunch client. If you go down the DIY route, we’ll even refund the fee if you decide to become a Crunch client. Our article on setting up a limited company has all the information you need, or you can talk to one of our advisers.
Q: How should I estimate my income/turnover?
A: At its simplest, base it on your day rate and how many days a week (and weeks per year) you’ll be working – factoring in any expenses you’ll have. Our simple take-home pay calculator can help (it will also show whether you’d be better off as a sole trader or a limited company). If you want to get more detailed, then you may want to take a look at our cash flow forecasting spreadsheet.