Understanding the tax treatment for sole traders in the United Kingdom is crucial for managing your business finances effectively. Sole traders, unlike limited companies, operate without legal separation between personal and business finances. This structure may be simpler, but it comes with unique tax obligations.

What It Means to Be a Sole Trader

As a sole trader, you take home all the profits after taxes, but you are also personally responsible for any business debts. For instance, Alex, a freelance photographer, must manage his income and expenses carefully to ensure proper tax reporting. Similarly, registering with HMRC is a vital first step. Sole traders need a Unique Taxpayer Reference (UTR) to file annual self-assessment tax returns.

How Taxation Works for Sole Traders

Sole traders are taxed on their business profits, not their total income. For example, Sarah, a baker, earns £40,000 from her sales but spends £10,000 on business expenses. Her taxable profit is £30,000. In the UK, income tax thresholds vary, with a personal allowance of £12,570. Any profits exceeding this amount are taxed at rates between 20% and 45%, depending on the income bracket.

National Insurance Contributions

Additionally, National Insurance Contributions (NICs) apply to sole traders. Class 2 NICs are a flat rate, while Class 4 NICs depend on profits, with rates starting at 9% for profits over £12,570. For Sarah, this would mean an NIC bill of £1,748 in addition to her income tax.

Key Deadlines and Record-Keeping

It is important to file your tax return by 31 January following the tax year. Keeping detailed financial records simplifies the process and ensures compliance with HMRC requirements. Tools like BudgetWiz can help with tracking income and expenses efficiently.

Final Thoughts

Managing the tax treatment for sole traders may seem daunting, but it becomes manageable with proper guidance. For more tips and insights, listen to the I Hate Numbers podcast, where we simplify finance for business success.

When choosing a business structure, traditionally, we look at becoming a sole trader or a limited company and inevitably tax is going to be part of that decision making. In this week's podcast, I'm going to talk you through the tax treatment of sole traders in the United Kingdom. Now, whether you've just started your business, you've been running it for a while, understanding how taxes interact, how they work, is a pretty important piece of information. But don't worry,

I'm going to keep things simple, explain things on a step by step basis and throw in some examples, just to give some clarity and some insight. Let's crack on. Now, firstly, let's remind ourselves, what is a sole trader? Now, a sole trader is somebody who runs their own business as an individual.

It's the simplest type of business to set up in the United Kingdom. And no doubt, it's the simplest structure all around the world. Now, whether you are a sole trader, bear in mind there is no legal separation between you and your business. You keep all the profits after tax, but you're also personally responsible for any debts the business incurs.

Let's throw in an example of Alex, who happens to be a freelance photographer. Alex decides to set up as a sole trader, and his photography services, his income and expenses all are mixed in with his personal finances. Now, his first thing he needs to do in terms of tax, he needs to register as a sole trader with the authorities.

And the authorities in the United Kingdom that will be dealing with your taxes is HMRC, which is the shorthand version of Her Majesty's Revenue and Customs. Other terms do exist, but this is a family podcast, so I'm not going to go down that route. Now, registering with HMRC can be done online, and also it's free.

If you're not too comfortable with forms, etc, you can talk to your advisor, they can support you in that process. Now, once you're registered, HMRC will issue you with a tax reference. It's called a unique tax reference, normally abbreviated to UTR. It's a 10-digit number, and it's important and it's critical because without that not only will you not be able to file your return, you're not going to be able to communicate effectively with HMRC.

Now as a sole trader, the ultimate responsibility for filing, completing the tax return falls on your shoulders. And it's an annual exercise. Obviously, you can allocate that, delegate, use an accountant to do that for you. Ultimately, it's your responsibility for the content of that form. Now, your self-assessment return is how you report your income, and also the mechanism by which you calculate how much tax you owe.

Our next consideration is, what is it you're actually taxed on? Now, as a sole trader, you're not taxed on the invoices you issue to customers, but you're taxed on the profits your business makes. And these profits are business profits. Now, profits are worked out by essentially taking into account your income, i.e.

the services you provide, the products you produce and sell on, and taking away your allowable business expenses. Let's throw in another example. Now imagine Sarah. Sarah runs a small baking business. Now, in one particular year, she earns 40,000 pounds from selling her cakes and pastries and the like. And that's 40,000 pounds by the way, in terms of what's going through as her sales.

Now in order to do that, she has to spend 10,000 pounds on flour, ingredients, packaging and other costs. And her profit then, is the 40,000 minus the 10, which equals 30,000 pounds. And we're assuming, by the way, that the outgoings of 10,000 are all business-related. Now, this is the figure, the 30,000 that Sarah will ultimately be assessed to tax on. Now, it makes no difference by the way,

whether Sarah spends all that profit or doesn't touch any of it, as a sole trader, you are taxed on the entire profit that you generate, not what you actually spend. The next thing to consider is to have a look at the rates that are applicable to sole traders. Now, tax rates change all the time, so always make sure you keep in touch.

Check out the HMRC website. Check our own site here for links to those rates itself. Now, I'm going to be using the tax year what's called 24/25 and thank you the Church and the Romans. The tax year in the UK is a very peculiar one and it runs from the 6th of April of one year to the following 5th of April.

So when I say 24/25 we're essentially looking at the 6th of April 2024 to the 5th of April 2025. Now in the UK we use different bounds to calculate income tax. And for the year in question of 24/25, the rates are as follows: for the first 12 570, the rate applied is 0 percent, and that 12 570 by the way is your personal allowance. Anything above 12 570 up to and including 52070, you're paying tax at the rate of 20 percent, and this tax I'm referring to, by the way, is called Income Tax. Now any income over 52070 up to and including 125 grand 1 2 5 1 4 0 if you want to be precise, you're paying tax at 40%.

If you're in that situation where your profits are in excess of 125 odd thousand, then it's 44 percent that will apply. Now, let's go back to Sarah with her 30,000 pound profit. The first 12, 570 is free is covered by her Personal Allowance, and it's free from income tax, and she will then pay 20 percent on the excess over 12, 570.

That excess, by the way, I hope you've got your pen and paper to hand, is 17, 430, and that then forms the basis on which she works out her income tax, which is 3486. Please check my workings. The next tax to consider, by the way, and it tends to be forgotten by many people, is National Insurance Contributions.

Now, National Insurance Contributions, the approach is very similar to income tax, the allowances are very similar as well, and in a sole trader business, you've got two types of National Insurance. You've got something called class two. It's that small flat rate one, was currently £3.45 per week for profits over 12,570.

That is an important contribution, by the way, to make because goes towards your state pension, and it goes towards National Insurance based benefits that you may need to access at some point in your life. As a spoiler alert, as a footnote folks, if your profits are below that figure, you do get a credit and you can volunteer to pay that, but that's a topic for another podcast.

The other type of National Insurance you're gonna have is what's called Class 4, and that's paid at the rate of 9% for your taxable profits over 12 570, up to including that 52 070. And then you pay a 2% supplement when those profits exceed 52 070. So we go back to Sarah, a 30,000 pound profit. She pays class 2, 52 weeks worth at 3 pound 45.

She pays 9 percent National Insurance Class 4, on the profits over 12,570, which is about another 1,568. In total, her National Insurance bill is 1,748. Now bear in mind folks, National Insurance is a tax. Tax comes in many guises, has different names, but it's a tax, nevertheless. Now, another step in the process, obviously, in order to arrive at those figures, Sarah would have had to complete her personal tax return.

Again, we have hundreds of clients who ask us to support them, take the stress out and complete their tax returns. If you don't have an accountant and you feel comfortable, it's quite possible to do it on a DIY basis. There are resources out there, but if you think you want that support, then you need to approach and get yourself an accountant.

Now, completing your tax return is where you have to report your income, expenses and profits, and also if you've got any other income outside of your self-employed profits. Now, the key dates to remember is that the tax year, as I mentioned earlier, has this peculiarity running between the 6th of April and the following 5th of April.

Now if we take the tax year 23/24, so that's 6th of April 23 to 5th of April 24, in deadline times that tax return must be filed and completed by the 31st of January 2025. So that’s the 31st of January after the end of the tax year, and any money that you owe in respect to that year must also be paid by the 31st of January. A good thing here, make sure if you put money aside to pay that tax, if you haven't, as a rule of thumb,

I would suggest for every 100 of income, what your sales are, put a percentage away to cover that future tax bill. Now, underpinning all this, it's really important that as a sole trader or any business entity, you keep good records. Now, tracking your income, your expenses, not only enables you to understand how much profit you're making, but it's the basis of the information that you need to complete your tax return.

If you do indeed have an accountant who does your tax return for you, then making sure your records are kept orderly will make sure your bill is managed more effectively because there'll be a time saving all round. Now you can use a spreadsheet, you can use accounting software, whatever you do though, make sure you've got some good structured way to keep those records.

Clear records makes finding your tax return much easier and less of a time-consuming stressful exercise. Also bear in mind, folks, by the HMRC always reserve the right to look at your records, and you must keep them for at least six years, and the essence is your records must support the entries that go to your tax return.

So folks there you have it, an overview of how tax works that's giving you an insight to how the system works in the United kingdom. If you're unsure, consider getting advice from an accountant. By all means, drop us a line. Use tools like Budgetwhizz to manage your finances, our online financial planning platform.

Hope you found this podcast useful, and don't forget to like and subscribe for more. Until next time, happy tax returning. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.