If you work for yourself, learning how to budget for your tax bill is part of running the business. Unlike an employee, you do not usually have an employer deducting all of your Self Assessment tax before the money reaches you.

That can create a nasty surprise if you spend everything coming into the business and only think about tax when the payment deadline arrives.

The better approach is to treat tax like any other business cost. Estimate what you are likely to owe, put money aside regularly and keep your records up to date so the eventual bill is something you have prepared for rather than something you fear.

About this episode

Moving from employment into self-employment changes your relationship with tax.

When you are employed, much of the administration happens before your wages reach you. Once you work for yourself, responsibility shifts.

You need to keep appropriate records, understand the profit your business is making, deal with your tax return and make sure the money is available when your tax becomes due.

That can sound exhausting, but the practical principle behind this episode is simple:

Tax is a cost. Budget for it before you spend the money elsewhere.

Think of your business as your employer

One useful mindset is to imagine that your business employs you.

As a sole trader, you and the business are not legally separate in the same way as a limited company. However, making a mental distinction can still be useful.

When money comes into the business, do not automatically treat every pound as available to spend personally.

Part of that money may eventually need to pay tax.

Separating those two ideas can make budgeting much easier. Instead of seeing one healthy bank balance and assuming it all belongs to you, you begin to recognise that some of it already has another job.

What is your tax bill based on?

For a self-employed business, tax is not simply calculated on the amount of money you invoice or receive.

The starting point is your business profit.

Broadly, we look at your business income and allowable expenses, together with the relevant accounting and tax adjustments, to arrive at the profit used for tax purposes.

Your eventual Self Assessment bill can also depend on other income, allowances, reliefs and your personal circumstances.

Depending on your circumstances and profit level, the bill may include Income Tax and National Insurance as well as other amounts collected through Self Assessment.

If you want to understand that distinction more clearly, see Profit for Tax Explained: Why Tax Profit Differs from Accounting Profit.

How much should you put aside for tax?

There is no single percentage that works for every self-employed person.

Your tax position depends on your profit, other income and individual circumstances. Payments on account can also affect how much cash you need at particular points in the year.

So rather than relying blindly on a fixed percentage, start with an estimate of your likely tax bill.

Then turn that estimate into a regular savings target.

For example, if your latest estimate suggests you will need £6,000 for tax over the year, you can begin thinking in terms of putting aside roughly £500 a month, adjusting the amount as your actual profit develops.

The important thing is not whether the first estimate is perfect.

What matters is that you are building the habit of reserving money instead of waiting until January and hoping the cash is available.

Open a separate account for your tax money

A separate savings account can make the discipline much easier.

If all of your business money sits in one account, the balance can give you a false sense of comfort.

Some of that money may already be needed for tax.

By moving your estimated tax amount into a separate account regularly, you create a clear boundary between money available for running the business and money reserved for HMRC.

You could transfer money monthly, weekly or whenever customers pay you. Choose a rhythm that fits the way cash enters your business.

The purpose is simple: ring-fence the tax money before you accidentally spend it.

Good records make tax budgeting easier

You cannot estimate your tax sensibly if you do not know what your business is earning and spending.

Good bookkeeping gives you that information.

Instead of waiting until the end of the year to discover your profit, keep your records up to date throughout the year. You can then review your income, expenses and estimated profit while there is still time to adjust your tax savings.

Digital accounting systems can make this much easier by reducing the manual work and giving you a more current view of the numbers.

Our guide to cloud accounting explains how online accounting systems can support better financial records and decision-making.

Making Tax Digital and your records

Digital record keeping has also become more important because Making Tax Digital for Income Tax now applies to some sole traders and landlords.

Whether you need to use it depends on your qualifying income and circumstances.

If Making Tax Digital applies to you, you need compatible software to maintain digital records and send the required updates to HMRC.

Because the qualifying rules and thresholds can change over time, check the latest GOV.UK guidance or speak to your accountant before deciding what applies to you.

Do not forget payments on account

Payments on account are one reason a Self Assessment bill can feel larger than expected.

They are advance payments towards your next tax bill.

Where they apply, there are normally two payments. Each is usually based on half of the relevant tax from the previous year.

The first payment is normally due on 31 January and the second on 31 July.

There are circumstances where payments on account are not required, so do not assume that everybody pays them.

The important budgeting lesson is to check whether they apply to you before deciding how much money you need to reserve.

For a fuller explanation, see Payments on Account Explained: What They Are, When to Pay and How to Reduce Them.

Review your tax estimate during the year

Your first estimate should not be your last estimate.

Business changes.

You may earn more than expected, incur additional costs, lose a customer, win a large project or generate income from somewhere else.

Any of those changes could affect the eventual tax bill.

So review your estimate periodically and adjust the amount you are saving.

If profit rises strongly, increase the amount you put aside. If your expected liability falls, you can reconsider the savings target based on the updated numbers.

This is much better than relying on a percentage you chose several years ago and never reviewing it.

A simple tax budgeting routine

You do not need to become a tax expert to build a useful routine.

1. Keep your records current. Know what you are earning and spending.
2. Estimate your taxable profit. Use your accounting information rather than gut feeling alone.
3. Estimate the tax liability. Include payments on account where relevant.
4. Ring-fence the money. Move it into a separate savings account.
5. Save regularly. Monthly, weekly or when customers pay you can all work.
6. Review the estimate. Update it as your business performance changes.
7. Check the final calculation. Do not treat your budgeting estimate as the actual tax return calculation.

The goal is not mathematical perfection every week.

The goal is to avoid reaching the tax deadline with no plan and no money set aside.

Why budgeting for tax reduces stress

An unexpected tax bill creates stress because two problems arrive at once.

First, you have the tax liability itself. Second, you have to find the cash to pay it.

Budgeting separates those problems.

You may not enjoy paying tax, but if you have already reserved the money, the payment becomes a planned business transaction rather than a financial emergency.

That is the real value of treating tax like any other cost.

FAQs

How do I budget for my tax bill when self-employed?

Estimate your likely tax liability from your expected profit, put money aside regularly in a separate account and review the estimate as your business performance changes.

What percentage should I save for tax?

There is no universal percentage that works for everybody. The amount depends on your profit, other income, allowances, reliefs and whether payments on account apply. Use an estimate based on your own circumstances rather than relying on a generic percentage.

Should I have a separate savings account for tax?

It can be very useful. Moving estimated tax money away from your everyday business account makes it easier to see what cash is genuinely available to spend.

What are payments on account?

Payments on account are advance payments towards your next Self Assessment bill. Where they apply, HMRC normally asks for two instalments, one in January and another in July.

Why are good records important for tax planning?

Good records help you understand your income, expenses and profit. That makes your estimated tax bill more useful and allows you to adjust the amount you save before the payment deadline arrives.

Do I need Making Tax Digital software?

Some sole traders and landlords now need to use Making Tax Digital for Income Tax based on their qualifying income and circumstances. Check the current GOV.UK rules to confirm whether and when you need to use compatible software.

Episode Timecodes

• 00:29 - Why self-employed businesses should budget for tax
• 01:13 - Moving from employment to self-employment
• 02:04 - Treating tax as a business cost
• 02:30 - Thinking of your business as your employer
• 03:13 - What self-employed tax is based on
• 04:31 - Income Tax and National Insurance
• 05:33 - Understanding payments on account
• 06:17 - Building the right tax budgeting mindset
• 06:37 - Using a separate account for tax
• 07:20 - Why good records matter
• 08:09 - Estimating what you owe
• 08:58 - Putting money aside regularly
• 10:35 - Final tax budgeting summary

Related episodes and guides

• Payments on Account Explained: What They Are, When to Pay and How to Reduce Them
• Tax Basics for Self Employed: What You Need to Know
• Self Assessment Tax Returns
• Profit for Tax Explained: Why Tax Profit Differs from Accounting Profit

Key takeaway

Do not wait for the tax bill before you start thinking about the money.

Treat tax as a normal cost of being in business. Keep good records, estimate what you are likely to owe and move money aside regularly.

A separate tax account can help create the discipline, while regular reviews keep your estimate connected to what the business is actually doing.

Most importantly, remember that the money sitting in your business bank account is not necessarily all yours to spend.

Prepare for the tax before HMRC asks for it, and the eventual payment becomes far easier to manage.

Plan it, Do it, Profit.

Further Support

If you want help understanding your tax, profit and other business numbers, use our free online business calculators.

If you need help estimating your tax bill, preparing your Self Assessment or planning ahead for tax payments, you can contact us for an initial chat.

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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You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.

What's the difference between a taxidermist and the taxman? Well, the taxidermist leaves the skin on. Today's podcast is about tax, more particularly, how you as a self-employed business should budget for your tax bill. Hi, folks. My name is Mahmood. I'm an accountant with his own firm of 26 years. I'm an educator and a mentor, and I've just taken a short break from preparing and filing tax returns in the UK for my clients,

and I want to share with you some thoughts and tips that I share with my client base about why you should budget for your tax bill, how you should go about it, and some great useful tips that you can use in your own self-employed business. Now, I think the first thing I want to talk about is why you should bother?

If you have been in the world of work as an employee, you know that your employer will be taking responsibility for administering all the tax rules, will be taking money off you, as you are paid on a weekly or monthly basis, take care of all that, and then paying it over to the authorities. When you make that transition to the world of self-employment, running your own business, then you have multiple tasks to deal with, and one of those is that you are responsible for your own tax.

Not just paying it, but making sure that the requisite forms, make sure the documentation, the rules and regulations are complied with, and then typically, once a year, you'll be submitting a tax return to authorities and paying any tax that's due. Now, this could be quite a shock for you in terms of when you get an unexpected amount coming out.

For me, I want to emphasise the fact that tax is a cost, like all other costs. The merits of budgeting for that to minimise the level of anxiety, to minimise that sudden pain when suddenly a great big, unexpected liability appears, and that's the focus of the podcast. Following on from that, if you are in the world of employment, as we said, then all the responsibilities for tax collection, tax paying over is delegated to your employment.

Now, for self-employed, tax is not collected off your earnings as you make them. They're typically collected once a year. First thing you need to do in your self-employed business is to make a visualisation and consider your sole-trader business as effectively your employer. And your business is employing you to work in the business.

If you make that visual distinction in your own mind, if you make that psychological separation, then you will see clearly that all the profits that you generate, all the tax that's due on that profit doesn't actually belong to you. It belongs to authorities. So, having that clear visualisation makes it much easier to get that discipline in.

The second thing I'm going to share with you is what is taxed levied on? Now, we're talking self-employed individuals here. We might call them sole traders. We might call them freelancers. And effectively, you are taxed on the level of profits that you create and make in your self-employed business. Usually that will be what you are invoicing, what you are selling to your clients, deduct any expenses such as advertising, travel costs, maybe renting facilities, paying your accountant.

Let's get that one in there. The difference in there, between those two, is profits, and profits is going to be the name of the game for your self-employed business. Now, it's that figure that's left over, that profit is what you are taxed on, and in the UK, typically, you pay two types of tax. You'll be paying income tax and you'll also be paying national insurance.

Let's take that tiny step back here. So, we've got this idea that's as a sole trader, a self-employed business, profits that you make are what is going to be taxed. You will potentially be paying income tax and national insurance. Now, the purpose of this podcast is not to talk to tax experts. It's to give you a very helpful framework, a very practical jargon-free way of approaching your business.

At the end of the podcast, I'm going to show you some tips and tools that you can use to actually work out the numbers of the level of taxes owed on the profits that you make. Let's go back to this idea of income tax and national insurance. In the UK, you are allowed to have a certain level of income

which is free of tax. For the year 2021, it's twelve and a half thousand. The purpose of this podcast is to give you a framework, by the way, so please always check the actual rates and check the calculator at all that I'm going to refer you to at the end of the podcast. Anything over twelve and a half thousand will be taxed at 20%.

Another tax that is levied, which a lot of self-employed people aren't aware of fully and escapes them, is that you also have to pay national insurance. It's at a different level, and for the year 2021, anything over nine and a half thousand is taxed at the rate of 9%. So, what we then have is a situation of you have a pool of profits, taxes levied on those profits,

and it's taxed at 20% or 9%. Again, the actual rates we don't need to concern ourselves with. It's just the idea that profits potentially equate to tax being levied. Now, one more sting in the tail, so to speak, is if the tax that you owe the government is over a thousand pounds in the UK, then you also have to pay an additional 50% upfront, which is what's called payment on account.

Think of it like an installment of tax going towards your following year’s tax bill. Now, tips-wise, how do we actually approach this? So, we've got the idea that we should be budgeting for our tax bills. We've got this idea of what tax is levied on. It's effectively profits from your self-employed business, and these are tax profits.

You pay national insurance and income tax. I've mentioned the rates. Now, let me share some tips with you. Now, the first one we mentioned at the beginning of the podcast is to visualise your business as your employer. You are the employee in your business. Now, fundamentally, in real terms, you and the business are one of the same.

You are working for yourself, but in terms of that visual distinction, that's not only useful for tax, but it's useful for also other disciplines. More on that in a future podcast. Number two, have a separate account. Now, lots of self-employed businesses will have one bank account and everything will flow through that.

So, when they look at the bank balances, they think, oh, that looks very healthy, but within that is buried monies that are going to be paid out to the tax authorities. So, my view would be, my recommendation, my tip would be: open up a separate bank account, open up a separate savings account and ring fence, and put money aside on a regular basis to go towards paying that tax bill.

Take it out of your main current account. Put it to one side. Number three, keep good records. Now ,I'm a big fan of the digital world when it comes to keeping records, getting that heavy lifting done. Check out previous podcasts where we've talked about digital accounting. Check out the show notes at the end where we will provide links to how you go about this. Absolutely critically these days where you are an acorn-size business or a mighty oak tree of a business, you need to have a really good digital

online bookkeeping system. It's not only good for tax purposes, by the way, but it serves a whole host of other good things. But when we're talking about tax, knowing what you've got to pay potentially, then you need to have good records. The fourth thing you do, the fourth tip is to actually make sure you have an estimate of what you owe.

Now, it took me several years through my professional exams, and my tax exams, and other qualifications to get experienced, to gain that knowledge, and I've got effectively 35+ years of experience. So, I'm au fait and comfortable with the UK tax regime. It does make my head hurt on occasion. So, this is not about making you a tax expert, it's about giving you a guesstimate, a good guesstimate of what your tax exposure will be.

So, you've got to calculate it, and what I'm going to share with you, folks, in the podcast notes is a link to a tax calculator, and the tax calculator is geared for sole traders, self-employed, and also as a Brucie Bonus, I’ve thrown in a tax calculator if you're a corporate body. The principles still apply. If you run your business through a limited company, that limited company will have a tax bill.

It doesn't have the same free allowances and the tax calculator copes with companies as well as sole traders. So, that will alleviate you of the heavy lifting and the mathematical gymnastics you've got to go through. The last thing I would recommend is what I call a rule of thumb. So, if you are invoicing clients, it's always good to have what I call a rule of thumb

about how much of that invoice should you put away for your savings. There are three numbers I'm going to share with you. Now, if your self-employed profits in the UK are in the order of about 15,000 pounds, then put away 10% of whatever you invoice to a client. So, if you invoice a client or charge a client 100 pounds, 10% of that, 10 pounds, put to one side to cover the tax that's due on that invoice.

If your profit's in the order of 25,000, then you want to be putting around about 23% away. Again, if you like easy numbers, 20% will work and that'll cover, not necessarily everything, but it'll cover the majority of your tax bill, including your payments on accounts. Now, if you are in that situation where your profits are hovering to the 50,000 pound mark, and this is your profits from your business, so that's what you're charging less any expenses, then you want to be putting 33% of what you invoice to a client.

So, 100 pounds at the lower end is 10 pounds and the upper level is 33, and that will cover pretty much the majority of your tax. Now, bear in mind, that's not the actual detailed answer. You have to complete a tax return. You have to think about the release, but that's pretty much going to keep you on the straight and narrow.

So, let's summarise what we've got here, folks. How you should budget for your tax bill? Well, first of all, you need to, because you don't want those nasty shots coming out. You have a responsibility. It's a legal obligation, and you want to make sure you've got that covered. And tax is like any other cost that you should be budgeting for.

Number two, we've talked about what you are taxed on, and it's fundamentally the profits that you make in your business. Number three, we've shared some tips as to how you go about that. Folks, have a look at the show notes. Check out the reference to the tax calculator that's in there. Hope you have a fantastic week.

I'll look forward to catching you in the airwaves next week. And if you liked the podcast, which I hope you have, I'd love it if you could share it, feedback, comment, and if you've got some thoughts for a future podcast, what you'd like covered, let me know accordingly. Faith in that. Have a brilliant week. 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.