Starting a small business as a sole trader in the UK is an exciting step, but understanding how much tax you’ll pay can be daunting. In this guide, we’ll break down the key taxes you’ll need to consider, how they’re calculated and the deadlines you need to keep in mind as a sole trader.
What is a Sole Trader?
A sole trader is someone who runs their business as an individual and is personally responsible for its debts. It’s the simplest business structure to set up and is ideal for freelancers, contractors, and small business owners. The key difference between being a sole trader and having a limited company is that you and your business are legally the same entity.
Key Taxes for Sole Traders
As a sole trader, there are three main types of tax you need to be aware of:
- Income Tax
- National Insurance Contributions (NICs)
- Value Added Tax (VAT) (only if your turnover exceeds the VAT threshold)
One common area of confusion new business owners is that sole traders do not pay corporation tax.
Let’s look at each in more detail.
1. Income Tax
Income tax for sole traders is based on your business profits, which is your total income minus any allowable business expenses. The amount of income tax you pay depends on your profit level and the UK’s income tax bands.
For the 2023/2024 tax year, the income tax bands are as follows:
- Personal Allowance (up to £12,570) – 0% tax
- Basic Rate (from £12,571 to £50,270) – 20%
- Higher Rate (from £50,271 to £125,140) – 40%
- Additional Rate (over £125,140) – 45%
The first £12,570 of your income is tax-free due to the personal allowance, unless your income exceeds £100,000, in which case the allowance reduces by £1 for every £2 above that threshold. If your profits are under £12,570, you won’t owe any income tax.
Example:
If your annual business profit is £30,000, the first £12,570 would be tax-free. You’d then pay 20% income tax on the remaining £17,430, which comes to £3,486 in income tax.
2. National Insurance Contributions (NICs)
As a sole trader, you’ll pay two types of National Insurance: Class 2 and Class 4.
- Class 2 NICs: If your profits are over the Small Profits Threshold (£12,570 for the 2023/24 tax year), you’ll pay Class 2 NICs at a flat rate of £3.45 per week. This works out to around £179.40 per year.
- Class 4 NICs: If your profits are above £12,570, you’ll also pay Class 4 NICs. The rate is 9% on profits between £12,570 and £50,270, and 2% on profits above £50,270.
Example:
If your annual profit is £30,000, you would pay:
- Class 2 NICs: £179.40
- Class 4 NICs: 9% on £17,430 (i.e., £30,000 – £12,570), which is £1,568.70
3. Value Added Tax (VAT)
You only need to register for VAT if your turnover exceeds the VAT registration threshold, which is currently £90,000 per year (as of 2024). If your business turnover is under this threshold, VAT is optional, but some businesses choose to register voluntarily as it allows them to reclaim VAT on purchases.
Once registered, you’ll need to charge VAT (usually 20%) on most of the goods and services you sell and submit VAT returns, usually quarterly. You’ll also be able to reclaim VAT on eligible business expenses.
How to Calculate Your Tax Bill
To calculate your total tax bill as a sole trader, follow these steps:
- Work out your business profit: Add up all your income and subtract any allowable business expenses (e.g., office supplies, travel, rent, marketing costs).
- Subtract the personal allowance: Deduct £12,570 from your profit if your total income is below £100,000.
- Calculate income tax: Apply the relevant tax rate to your remaining profit based on the UK income tax bands.
- Calculate National Insurance: Add Class 2 NICs (£179.40) and Class 4 NICs (9% on profits between £12,570 and £50,270, plus 2% on profits above £50,270).
- Consider VAT (if applicable): If you’re VAT-registered, remember that VAT is separate from your income tax and NICs. You’ll need to submit VAT returns and pay any VAT owed to HMRC.
Example: Complete Tax Calculation
Let’s say you’re a sole trader with a profit of £40,000 for the year. Here’s how your tax calculation might look:
- Income Tax:
- First £12,570: 0% tax = £0
- Next £27,430 (i.e., £40,000 – £12,570): 20% tax = £5,486
- Class 2 NICs: £179.40 (as profit is above the Small Profits Threshold)
- Class 4 NICs:
- On £27,430 (i.e., £40,000 – £12,570): 9% = £2,468.70
Total Tax Bill:
- £5,486 (income tax) + £179.40 (Class 2 NICs) + £2,468.70 (Class 4 NICs) = £8,134.10
Tax Deadlines and Payments
As a sole trader, you need to complete a Self Assessment tax return each year. The deadline for submitting your tax return online for the 2023/24 tax year is 31st January 2025. You’ll also need to pay any income tax and NICs owed by this date.
HMRC may require you to make payments on account if your tax bill exceeds £1,000. This means you’ll pay your tax in two instalments: 50% by 31st January and 50% by 31st July of the following year.
Reducing Your Tax Bill: Expenses and Reliefs
You can reduce your taxable profit by claiming legitimate business expenses. These may include:
- Office supplies (e.g., stationery, equipment)
- Business travel (excluding your daily commute)
- Professional fees (e.g., accountancy services)
- Marketing and advertising costs
- Home office expenses (if you work from home)
Additionally, sole traders can benefit from certain tax reliefs such as capital allowances for equipment purchases or tax-deductible pension contributions.
Conclusion
Understanding how much tax you’ll pay as a sole trader in the UK is crucial for planning your finances. Your total tax bill will depend on your business profit, the income tax rates, and National Insurance contributions. By keeping good records, making use of allowable expenses, and submitting your Self Assessment on time, you can manage your tax obligations effectively.
If you’re ever in doubt, it’s always a good idea to consult an accountant or tax advisor to ensure you’re meeting all your obligations and making the most of the tax reliefs available to you.