If you work for yourself, as a sole trader, you will need to register with HMRC as self-employed unless you earn less than £1,000 in a tax year. Registering will set you up for both self-assessment tax returns and the relevant National Insurance Contributions (NICs).
It is advisable to register with HMRC as self-employed as soon as possible but this must be done by 5 October following the end of the tax year in which your business started. Failure to do so can leave you subject to penalties.
Which Taxes Apply?
Trading income less allowable expenses (profits) will be subject to the following taxes:
Income Tax will be charged on income above your personal allowance (£12,500 for 2019/20 for incomes under £100,000) at a rate of 20%/40%/45%, depending on your personal circumstances.
National Insurance: Sole traders pay less in National Insurance than their employed counterparts, with Class 4 NICs due at 9% on profits between £8,632 - £50,000, and 2% on amounts above £50,000. Sole traders also pay Class 2 NICs at a flat rate of £3 per week.
Example: Lucy has taxable profits of £30,000 in 2019/20 having been self-employed throughout the tax year. Lucy starts her business on 6 April 2019 and must register with HMRC as self-employed no later than 5 October 2020. Assuming there is no other income, Lucy’s tax liability for 2019/20 will be as follows:
Tax free within personal allowance: £12,500
Income tax £17,500 @ 20% = £3,500
Class 4 £30,000 - £8,632 = £21,368 @ 9% = £1,923.12
Class 2 £3 x 52 weeks = £156
This gives Lucy a liability of £5,579.12 for the 2019/20 tax year.
When do I pay the Tax?
Once registered as self-employed you will be issued with a UTR (unique tax reference number) so that you can file tax returns. These are due by 31 January following the tax year, alongside payment of your outstanding liability of income tax and NICs.
In some cases, you will also fall into the Payments on Account regime. These are advance payments of tax towards the following year’s liability. Each payment is equal to half your previous year’s tax liability and these are due on 31 January and 31 July with any balancing payment still due by the following 31 January.
Example: So, Lucy from our example above, would owe £5,579.12 by 31 January 2021 for 2019/20. Lucy would also owe payments on account towards her 2020/21 tax liability, each in the sum of £2,789.56. These would be due by 31 January 2021 and 31 July 2021 respectively.
This is often painful in the first year of the regime, as you must produce 1.5 x your tax liability in the January following the tax year in which you made the profits. It is therefore prudent to prepare the calculations in good time, so that you can put the money aside.
Sole Trader or Limited Company
The question of whether to be a sole trader, or limited company is one best answered on a case by case basis, as the answer will also depend on several factors such as other sources of income, and how much remuneration is required by the individual. However, once you are generating larger profits, it is often more tax efficient to incorporate.
What Expenses Can I Claim?
Once you have taken the decision to act as a sole trader, it is important to discuss with your accountant whether to use the cash or accruals basis.
Whilst there are differences in what and how you can claim expenses for cash or accruals-based accounting, the general rule to bear in mind is that expenses must be wholly and exclusively for the purpose of the trade.
Examples of standard expenses you can claim under either method are office supplies, travel (either by including actual costs or using HMRC’s simplified vehicle expenses), marketing, staff, stock etc.
One of the main differences between cash and accruals is the ability to claim capital allowances. For cash accounting, most capital expenditure is simply allowed as a deduction (cars being an exception to this). Under the accruals basis, capital expenditure cannot usually be deducted in calculating taxable income, and capital allowances can be claimed instead. Careful consideration is needed for these complex rules when preparing the accounts, to ensure you are utilising the best claims for your business.
You should retain records for at least 5 years after the 31 January following the tax year in case you are subject to a tax enquiry. Here at Hippey Accountancy we use cloud-based apps to make life easier in this regard. Through the apps you can easily upload income and expense details to have an up to date picture of how your business is doing, and it takes away the need for boxes of receipts in the loft, as they are all stored securely in the cloud.
If you would like advice for your business, or have any questions, please do not hesitate to contact us on 01908 597 904.