Sole trader tax: paying tax as a sole trader
Sole Traders in the UK must pay their tax liability by submitting a self-assessment tax return each year. While paying tax as a sole trader is relatively straightforward – it’s crucial it’s done correctly and in accordance with HMRC. Failure to pay the right amount of tax and National Insurance Contributions, or submitting a late tax return could result in an unwelcomed fine.
This page will explain paying tax as a sole trader. And, at the end of this piece, there are a few tips that we hope you’ll find useful.
Sole Trader: An overview
The amount of tax and National Insurance Contributions that a sole trader is responsible for depends on the profit they make during a tax year. To calculate your tax liability, it’s essential to keep tabs on all incoming and outgoing money related to your business. Essentially, you are taxed on the difference between your turnover (incoming money from clients), and the outgoings your business occurs (expenses that were generated entirely as a result of your business activity).
Sole Trader: Tax
The more a sole trader earns, the tax they will be required to pay.
The Personal Allowance
The current personal allowance (2020/21) is £12,500, meaning you will not be required to pay tax on profit between £0.00 and £12,500.
Basic rate tax
If your profits during the tax year are between £12,501 and £50,000, you’ll be required to pay 20% tax on this amount.
Higher rate tax
The higher rate tax band is between £50,001 and £150,000. Therefore, if your profit falls within this amount, you’ll be required to pay 40% tax on the amount that exceeds the basic rate tax band.
Additional rate tax
On profit over £150,000 – you’ll be required to pay 45% tax.
Sole Trader: National Insurance Contributions
Having read the above, you may be thinking that sole trader tax is fairly straightforward – and you’d be right. However, National Insurance is not as easy to understand.
If you later decide to start a limited company, you’ll be required to pay Class 1 National Insurance. However, sole traders pay Class 2 and Class 4 National Insurance instead. Let’s look into these in more detail:
Class 2 National Insurance
- Paid via direct debit – for sole traders earning profits over £6,475 (in a tax year).
- £3.05 per week.
- If you don’t think you qualify for Class 2 National Insurance, you’ll need to notify HMRC.
- If eligible, you need to register to pay Class 2 National Insurance, and this can be done as soon as you start your business.
Class 4 National Insurance
- Unlike Class 2 National Insurance, Class 4 National Insurance is paid when you submit your self-assessment tax return, along with your income tax.
- Worked out as 9% of a sole trader’s profit between £8,632 and £50,000.
- If profit exceeds £50,000, an additional 2% must be paid on the additional profit.