Tax treatment for sole traders matters because, when you run your business as an individual, you are taxed on the profits your business makes. You also remain personally responsible for reporting income, keeping records, filing your Self Assessment tax return and paying the tax and National Insurance due.

About this episode

Choosing a business structure is one of the first big decisions we make when starting or growing a business. For many people, the choice is between operating as a sole trader or setting up a limited company.

In this episode, we explain how the tax treatment for sole traders works in the UK. We look at what it means to be a sole trader, how registration works, what profits are taxed, how Income Tax and National Insurance fit in, and why records matter.

If you want a wider comparison before looking at tax in detail, our episode on Sole Trader or Limited Company: Which Is Best for You? is a useful starting point.

Why sole trader tax treatment matters

Sole trader tax treatment matters because there is no legal separation between you and the business. You keep the profits after tax, but you are also personally responsible for the business debts and tax obligations.

That makes the structure simpler, but it does not remove responsibility. You still need to register where required, file the right returns, keep records and set money aside for tax.

Understanding the basics helps you avoid surprises, especially when your profits grow, your tax bill increases, or you begin comparing sole trader status with a limited company structure.

Key points from this episode

What is a sole trader?

A sole trader is an individual who runs their own business. It is one of the simplest ways to start a business in the UK.

As a sole trader, there is no separate legal identity between you and the business. The business income, expenses, profits, debts and responsibilities connect directly to you as the individual owner.

This simplicity can be helpful, especially when starting out. However, it also means you need to understand your tax position and personal responsibility clearly.

Registering as a sole trader

If your self-employed income is above the relevant threshold, you may need to register with HMRC through Self Assessment.

Once registered, HMRC issues a Unique Taxpayer Reference, usually called a UTR. This 10-digit number is important for filing your tax return and communicating with HMRC.

Registration is normally done online, and the usual deadline is 5 October after the end of the tax year in which you started trading. Always check the current HMRC position before relying on dates or thresholds.

What are sole traders taxed on?

Sole traders are taxed on business profits, not simply on money taken out of the business.

Profit is worked out by taking business income and deducting allowable business expenses. For example, if a business earns sales income and spends money on genuine business costs, the profit is the amount left after those costs are deducted.

That profit is then used to work out the Income Tax and National Insurance position. It does not matter whether the sole trader spends all the profit or leaves some of it in the business bank account.

Income Tax for sole traders

Income Tax is charged on taxable profits after allowances and reliefs have been considered.

The episode uses tax-year examples to show how rates and bands can apply. However, tax rates and allowances change, so any live page should avoid relying on old figures without checking the current year.

The key principle is that profits are added to your wider taxable income. Where your total taxable income sits within the tax bands will affect how much Income Tax you pay.

National Insurance for sole traders

National Insurance is another tax cost sole traders need to understand. The episode explains Class 2 and Class 4 National Insurance, which can apply depending on profit levels and the current rules.

National Insurance also matters because it can affect entitlement to the State Pension and certain benefits.

Because National Insurance rates and rules can change, check the latest figures before publishing examples or using older calculations. Our episode on National Insurance easily explained is a useful follow-on.

Completing a Self Assessment tax return

As a sole trader, you usually report your business income, expenses and profits through Self Assessment.

You can complete your own tax return if you are confident, or you can ask an accountant or tax adviser to support you. Either way, the responsibility for the accuracy of the return stays with you.

If you want a broader overview of the Self Assessment process, listen to Self Assessment Tax Returns: What to Include, What to Claim and Key Dates.

Key tax dates for sole traders

The UK tax year for individuals runs from 6 April to the following 5 April.

Your online Self Assessment tax return is usually due by 31 January after the end of the tax year, and any tax due is normally payable by the same deadline.

Payments on account may also apply. These are advance payments towards the next tax year and can affect cash flow if you are not prepared. Our episode on Payments on Account Explained: What They Are, When to Pay and How to Reduce Them explains this in more detail.

Keeping records as a sole trader

Good records are essential. They help you understand your profit, complete your tax return and support the figures if HMRC asks questions.

Useful records include invoices, receipts, bank statements, expense records, mileage logs and evidence of business income.

You can keep records in a spreadsheet, accounting software or another structured system. The important point is that your records support the entries on your tax return and make the job easier when filing time arrives.

For a practical next step, our episode on Bookkeeping for Small Business explains why regular bookkeeping supports better tax and business decisions.

Sole trader versus limited company

Sole trader status can be simple, flexible and cost-effective. However, it also comes with personal responsibility for business debts and tax.

When profits grow, it may be worth reviewing whether a limited company structure makes more sense. That decision should not be based only on tax. It should also consider risk, admin, profit levels, personal plans and how the business may grow.

For a structure-focused follow-on, listen to How to Change from Sole Trader to Company: Four Steps to Plan the Move.

What to check as a sole trader

• Have you checked whether you need to register with HMRC?
• Do you have your Unique Taxpayer Reference?
• Are your income and expense records up to date?
• Are your business expenses allowable?
• Do you understand that tax is based on profit, not drawings?
• Have you checked your Income Tax and National Insurance position?
• Have you saved money for the tax bill?
• Have you planned for the 31 January deadline?
• Could payments on account apply?
• Is it time to review whether sole trader status still fits?

FAQs about tax treatment for sole traders

What is the tax treatment for sole traders?

Sole traders are usually taxed on business profits through Self Assessment. Profit is business income minus allowable business expenses.

Do sole traders pay tax on drawings?

Sole traders are taxed on business profits, not on the amount they withdraw for personal use. Drawings are not normally treated as a tax-deductible business expense.

Do sole traders pay National Insurance?

Sole traders may pay National Insurance depending on their profits and the current rules. The rates and thresholds can change, so check the latest HMRC guidance before relying on figures.

Should a sole trader become a limited company?

It depends on profit levels, tax, risk, admin, growth plans and personal circumstances. Tax can be one factor, but it should not be the only reason for changing structure.

Episode Timecodes

• 00:00 – Why business structure and tax go together
• 00:25 – Keeping sole trader tax simple
• 00:45 – What a sole trader is
• 01:04 – Alex the freelance photographer example
• 01:23 – Registering with HMRC
• 01:42 – Unique Taxpayer Reference and filing responsibilities
• 02:36 – What sole traders are taxed on
• 02:54 – Sarah the baker example
• 03:43 – Tax on profit, not what you spend
• 04:01 – Tax years, rates and allowances
• 05:24 – Income Tax example
• 05:42 – National Insurance Contributions
• 06:46 – National Insurance as part of the tax cost
• 07:13 – Completing a Self Assessment tax return
• 07:31 – Key tax dates
• 08:20 – Setting money aside for tax
• 08:45 – Record keeping and software
• 09:06 – HMRC checks and keeping records
• 09:25 – Final thoughts and support

Related episodes

• Sole Trader or Limited Company: Which Is Best for You?
• Tax Basics for Self-Employed People: Register, Claim Expenses and Plan Tax
• How to Change from Sole Trader to Company: Four Steps to Plan the Move

Key takeaway

Tax treatment for sole traders is built around profit, responsibility and records. You are taxed on the profits your business makes, and you need to report those profits through Self Assessment.

Keep good records, understand your Income Tax and National Insurance position, save towards your tax bill and review your structure as the business grows.

Plan it, Do it, Profit.

“As a sole trader, you are taxed on the profit your business generates, not simply on what you withdraw or spend.”

Further Support

The I Hate Numbers podcast helps business owners understand accounting, tax, finance, profit, cash flow, and business planning in a practical way. We simplify financial topics so you can make better decisions and feel more confident with your numbers.

You can also watch more practical finance and tax support on the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

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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.