When you’re self-employed, it’s essential that you know how to manage your own taxes. Unlike when you’re in employment, there’s no one to do it for you, so you need to stay on top of it to avoid hefty fines from HMRC. So, what are the self-employed taxes that you need to be aware of, and what is the best way to manage your taxes when you’re operating as a sole trader?
In this article, we’ll tell you everything you need to know about taxes as a self-employed individual, including registering as a sole trader, filing your tax returns and paying your taxes.
Do self-employed have to pay taxes?
If you are self-employed in the UK, you will typically be operating as a sole trader. You will need to register as a sole trader with HMRC and complete an annual self assessment tax return. From this, HMRC will calculate how much tax and National Insurance you are liable to pay. You will then need to pay this by the following January. This gives you nine months from the end of the self assessment period to pay your taxes.
However, if you earn under the personal allowance threshold which is set at £12,570 for the 2021/22 tax year, you will not be liable to pay any income tax, as this is your tax-free earning allowance. Your income tax will only be calculated on any earnings above this threshold.
But how much tax will you need to pay, and how do you register as self-employed with HMRC? Read on to find out.
How much tax do you pay if you are self-employed?
How much tax you’ll be liable to pay as a self-employed individual in the UK will depend on your level of income. Your income is calculated after expenses have been deducted, so it is only your business’ profits that are taken into account.
The UK has a marginal tax band system for taxing income. This means that different rates of income tax are used to pay for government spending at different levels of income. The UK’s current marginal tax bands for the 2021-22 tax year are:
Basic rate taxpayers earn between £12,570 and £50,270 a year and pay 20% on earnings over £12,570
Higher rate taxpayers earn between £50,271 and £150,000 a year and pay 40% on earnings over £50,000
Additional rate taxpayers earn over £150,000 a year and pay 45% on earnings above this threshold
It’s also important to note that individuals who earn over £125,140 do not get a tax free personal allowance, so they will have to pay tax on their entire earnings.
So, from these bands, you will be able to calculate how much tax you are liable to pay on your business profits.
For example, if your business turns over £10,000 of profit per year, you will not need to pay any income tax.
If your business turns over £30,000 profit in a year, you will not pay tax on the first £12,570 of your profits, but the remaining £17,430 will be taxed at the basic rate of 20%. This means that you’ll be liable to pay income tax of £3,486.
If your business turns over £60,000 profit in a year, you will fall into the higher rate tax band. This means that your first £12,570 will be tax free. The next £37,700 will be taxed at the basic 20% rate, resulting in £7,540 income tax. The final £9,730 of your earnings will be taxed at the higher rate of 40%, resulting in £3,892 income tax. This means that your total income tax bill on a profit of £60,000 would be £11,432.
How to register for self assessment
If you have begun trading as a self-employed individual, you will need to register with HMRC as a sole trader for self assessment.
The process of registering as a sole trader is relatively straightforward. You can do this online, through the HMRC website, or by completing HMRC’s SA01 form.
As a sole trader, you are under a legal obligation to maintain accurate financial records for your business. This means keeping records of all of your business’ sales and expenses. You should save any receipts or invoices as evidence of these transactions.
You’ll also need to start sending a self assessment tax return to HMRC at the end of every financial year. The financial year runs from 6th April and ends on the following 5th April. Your tax return will need to be completed by the 31st January for the previous financial year.
As a self-employed individual operating as a sole trader, you’ll also be liable to pay income tax on any business profits, as well as Class 2 and Class 4 National Insurance contributions. This will need to be paid by 31st January, just under nine months after the end of the financial year.
So, the 2021-22 tax year will end on 5th April 2022, and your tax return will need to be completed by 31st January 2023. You’ll also need to have paid your income tax and National Insurance contributions in full by 31st January 2022. You can pay this in instalments, providing the full balance is cleared by this date.
Do self-employed people need to register for VAT?
Many self-employed individuals wonder whether they will need to register for VAT.
If your turnover is below the VAT registration threshold (£85,000 for 2021-22), you will not have to register for VAT. However, if your turnover exceeds this threshold and HMRC chooses to audit your personal tax return, you will need to provide evidence of a turnover below £85,000.
If your turnover exceeds this £85,000 threshold, you will need to register for VAT. You will then charge VAT to your customers and pass this onto Inland Revenue.
Do I need proof of self-employment for taxes?
As a sole trader, you will need to complete a self assessment tax return each year. From this tax return, your income tax and National Insurance payments will be calculated.
You do not need any proof of your self-employment to file your tax return, providing you are registered as a sole trader with HMRC. However, HMRC can choose to audit businesses, both on a random basis and if there are any suspicions that your tax return may not be accurate. For this reason, it’s essential that you keep accurate financial records, including invoices and receipts for any income and expenditure. This will help you to prove that your tax return is accurate, should HMRC choose to audit your business.
What qualifies as self-employment income?
In general, any income that you receive in your capacity as a business owner will be classed as self-employment income. This can include:
Income from services that you provide to clients. This could include design work or consultancy services provided to another company in return for payment
Income from selling goods/products which you either make yourself or purchase and then sell on
Income from renting out property that you own
If you earn money in any of these ways, you will need to register as a sole trader with HMRC and complete an annual self assessment tax return. You’ll also be liable to pay income tax and Class 2 and Class 4 National Insurance contributions on the profit from your business.
What records do I need for self-employment?
As a sole trader, it’s your responsibility to keep accurate financial records of all your business transactions. You should ideally use an accounting package or book-keeping software to help you with this. This will help you to prepare a self assessment tax return at the end of each financial year.
You will need to keep invoices and receipts detailing your business’ income and expenses. This will help when it comes to preparing your annual self assessment tax return, as well as giving you evidence to turn to if your business is audited by HMRC.
It’s also a good idea to schedule an annual review with an accountant. This can help to identify any errors or discrepancies in your records and improve your business processes going forwards.
Who is exempt from self-employment tax?
If you are earning money from self-employment and your turnover exceeds £1,000 per year (note – turnover, not profit), you will need to register as a sole trader with HMRC. As a sole trader, you will be required to file an annual self assessment tax return. From this, HMRC will calculate how much tax you are liable to pay.
If your profits are under the personal allowance threshold, which is set at £12,570 for the 2021-22 tax year, you will not be liable to pay income tax on your earnings. However, if your profits are higher than this threshold, you will need to pay income tax to HMRC by 31st January.
What happens if I don’t pay self-employment tax?
As a sole trader, you are responsible for making sure that your business meets its tax liabilities. If HMRC chooses to audit your personal tax return and finds that you have not paid enough income tax or Class 2 National Insurance contributions, they may take any necessary action against you to recover the balance of what is owed.
You may also face a penalty if HMRC believes that your tax return is inaccurate or incomplete.
However, in some cases, you may be able to request an informal time-to-pay agreement. This allows for the repayment of any underpaid tax and associated interest in instalments over a set period of time. This will help to avoid penalties and keep your business on track to meet other financial obligations.
What expenses can I claim as a sole trader?
As a sole trader, you are entitled to claim certain expenses which are solely related to the running of your business. These expenses include:
Business travel – You can deduct the cost of any work-related travel from business income. However, you must keep a record of each journey and be able to show that it was made primarily for business reasons
Subscription fees – Sole traders can claim the cost of subscriptions to up to two professional organisations from their annual turnover
Utilities/services – You can claim for any expenses incurred providing services to your business, such as providing gas or water
Routine repairs – You can claim for any routine repairs made to buildings and equipment used in the course of your work. However, urgent repairs are not deductible.
Office supplies – You can claim for any office expenses incurred that are solely related to your business operations. This includes things like use of a desk or surface, pens and stationery, toiletries etc.
Business equipment – You can deduct the cost of any equipment purchased for your business (e.g. laptops) but not if bought with personal funds
Private use allowance – If you are using part of your home solely for business purposes (e.g. a home office), you can claim for a proportion of the associated house insurance, council tax and water bills
Do I need to declare earnings under 1000?
You are legally allowed to earn up to £1,000 before declaring the income to HMRC. However, it’s important to note that this means £1,000 of turnover before expenses, not profit. As soon as you reach this £1,000 threshold, you must register with HMRC as a sole trader and begin completing an annual self assessment tax return.
Is self-employed profit before or after tax?
As a sole trader, your profit is your earnings after expenses have been deducted. You will declare this on your self assessment tax return, from which HMRC will calculate your tax liabilities. You will then be issued with a tax bill which must be paid by 31st January.
It’s estimated that around 15% of individuals in the UK are operating as sole traders, making this a popular route for earning an income. However, if you are self-employed, it’s essential that you understand the taxes that you’re liable to pay, as well as how you need to disclose these to HMRC.