Tax for sole traders works differently from other types of businesses. Due to their business structure, they don’t pay corporation tax as a limited company would. Similarly, they would not receive income gross if they fall inside IR35. A sole trader is a one-person business. To fund their business, sole traders rely on their assets, bank loans, or loans from friends and family. There is no legal separation between a sole trader and their business. Everything, from business assets and profits to obligations, is theirs.
As a sole trader, you must:
- Keep financial records
- Pay all taxes due
- Keep track of expenses
- Generate and track invoices
- File self-assessment returns
Advantages
Starting as a sole trader is the most legitimate kind of ownership. It is subject to fewer laws and restrictions than other types of organisations.
Sole traders keep all of their profits for themselves. As a sole trader, you have more control. You manage your company the way you want, without influence from anyone else. You are not required to engage with directors or shareholders, which means you will not compromise your vision.
Disadvantages
The main downside of this business structure is that you are legally accountable for all aspects of your business. Meaning you have unlimited liability and are personally liable for your company’s debts. As such, your assets might be at risk should you fail to pay off any debts.
Sole traders have fewer tax planning options. This is because any profit made is liable to Income Tax in the financial year in which it is generated. You cannot, for example, leave profits in your business and pay yourself later or in the next tax year.
Tax for sole traders: How does it affect you?
Sole traders pay tax on their profits through HMRC’s annual self-assessment system.
Sole traders are allocated a personal allowance (tax-free amount) that they can earn each year. It is £12,570 during the current tax year (2021/22). This allowance is the same for both P.A.Y.E. employees and self-employed sole traders.
Employees in the UK pay tax on their wages if their earnings exceed their personal allowance. They get a payslip at a specific time that lays out how much they have been paid and how much their company has deducted in National Insurance and income tax.
Every year that you are in business, you will have to pay taxes on your profits. You must report your wages to HMRC using their self-assessment system.
The deadline for completing the self-assessment is January 31st, and you must pay any tax owed.
You are not required by law to register your business until October following the first tax year in which you began operations; nonetheless, it is best to register as soon as feasible.
Sole traders must pay income tax on their profits for each tax year, which runs from April 6th to April 5th of the following year.
In addition, sole traders must pay Class 2 and 4 National Insurance contributions.
When calculating how much tax you must pay, you are allowed to account for legitimate business expenditures and offset them against your earnings.
These costs might include:
- Advertising and marketing
- Materials or inventory
- Internet or phone bills (for business use only)
- Property rental
- Utility bills
- Travel costs, including the cost of a corporate car and petrol