If you have recently stepped into becoming self employed as a ‘Sole Trader’, or are thinking about it, this is the guide for you.
If you are considering whether to be a Limited Company, there is an extended version of this guide available here, covering various points on that subject.
What do I need to tell the tax man?
You need to register with HM Revenue & Customs (HMRC) for a tax return as soon as possible. The timescale used to be 3 months but most guidance has removed this and been replaced with ‘as soon as you start’.
You will need to complete a ‘Self Assessment Tax Return’ each year.
You can register here, the links on that page differ if you have previously been self employed before or not, so ensure you select the option that best applies to you.
If you are new to self-employment you will be taken through a few quick steps to open an online account. You will want to do this for future use and if you complete your own tax return. You will then fill out an online form with your details / that of your business.
If you are not new to the tax return system, it’s a simple form to fill out online and send.
TIP: If you are very near the tax year end (5th April), consider a start date after this to avoid having to fill out another tax return for just a week period.
How do I pay Tax and National Insurance? When do I need to pay my tax?
You pay both (Income) Tax and National Insurance once a year on your tax return now. There is no need to provide accounts with your tax return, but best practice is to have these prepared to get the most accurate figures and make the best financial decisions.
Tax year runs 6th April – 5th April – best to run your accounting year in line with this or to 31/3. From experience working with clients, it is best to run your accounting year in line with this or to the 31st March.
You pay the tax AND National Insurance due by 31st Jan following the end of the tax year.
This is the same date you must file your tax return by, so don’t leave filing to the last minute as you will not know what tax is due until late.
If you owe over £1000 in tax for any one year, in most cases you will be asked to pay ‘on account’ (up front) for the next tax year. HMRC presumes you will earn the same amount again and the amount due will be the same amount of tax you have to pay this year, divided into two payments.
31st Jan 2020 you owe £1200. You would be asked to pay £1800 on 31st Jan 2020 (£1200 for the year, £600 up front for next) and then £600 on 31st July 2020 (the second £600 for next year). As you can see, this can be quite a lot to find it you are unprepared for it.
When you come to pay your next tax bill (and amounts up front) in 2021 you will have paid £1200 towards it.
What are the other key dates?
You may see reference to the 5th October for tax returns – this was the old paper deadline submission deadline and was important if you had tax debt you wanted taken from employment income.
There are other important deadline dates if you work in the construction industry engaging subcontractors or take on staff/have a payroll, but we will leave this for another article.
Do I need to be VAT registered? Should I be?
You need to be VAT registered (in most cases) when you reach £85,000 of sales.
Initially you only want to consider registration in a few circumstances (you provide mainly services to reasonable size/VAT registered companies for example).
If you do register, you will need accounting software to keep and submit your records digitally, in order to comply with the ‘Making Tax Digital’ requirements. The main players in the market will be compatible (Xero, Quickbooks, FreeAgent, Sage etc – see below). VAT is a complex tax and it is always worth seeking professional advice or book-keeping when you become VAT registered (or are looking to be).
You hear more about VAT in this video: https://www.youtube.com/watch?v=aZyPcdEPEQA&t=9s
Do I need a business bank account?
You need a separate bank account as best practice. Whether it is a ‘business account’ is up to you, however it is generally against a bank terms and conditions to trade through a personal account.
Business accounts with most banks will charge you ~£7 per month, some maybe free for a while if you are new (schemes/offers vary).
Business accounts will charge you to bank money in them (especially cash). Normally electronic payments will not be charged for, but check any potential tariff to be sure.
There are more ‘challenger banks’ emerging that are offering business accounts now, so choose whichever brand you feel most comfortable with, especially from a service level.
How do I keep my records? Do I need software?
HMRC are moving towards a digital tax system. Although delayed, they have plans for quarterly digital updates from everyone, so software should be considered, but not essential at this point. Xero and Quickbooks are the two market leaders in this area.
As a self-employed individual/sole trader, your records can be as simple as a list of all your income and expenses. Ideally this will be in a spreadsheet, with expenses by category (stationary, materials, software, etc). This is generally sufficient information to complete your tax return.
The ultimate/best practice records set up would have you using software, which will ‘reconcile’ your bank transactions against you income and expenses.
A separate list should be kept of big items such as a laptop. Really any bit of equipment over ~£150 that will last more than a year. For tax return purposes these go in a different box (Capital Allowances/Annual Investment Allowance boxes).
What can I claim against my tax / ‘put through’ my business?
The general rule is anything ‘Wholly and Exclusively’ for business use. The rules vary depending on Limited or not, but this concept is universal.
General list of standard items:
Travel / Subsistence
What about working from home?
There are two ways of doing this. Actual costs incurred, using a fair and reasonable way to work out the business amount, or the HMRC fixed rate of £10-£26 per month depending on how many hours you work at home.
We have a video on this here: https://www.youtube.com/watch?v=H8tP-rdT330&t=4s
How about vehicle costs
As a sole trader you can either use a HMRC mileage rate that covers all costs (fuel, insurance, the purchase price itself) or add up all your costs and use those.
You need to keep a mileage log for all your business journeys i.e how many miles, what you did/who you saw, date and locations.
The mileage rates at the time of writing are 45p a mileage for the first 10,000 miles in a tax year and 25p for mileage in excess of that.
If you use the second method you need to disallow some of the costs for when you use the car personally, again using a fair and reasonable method. This fair and reasonable method normally needs a mileage log to support it….
We have a video on this here: https://www.youtube.com/watch?v=XGcg1bvt_y0&t=11s
‘Business journeys’ are all that is claimable against your tax bill. The rules can be complex, but the key point to remember is ‘commuting’ between a ‘base of operations’ is not allowable. If you image, an employee can’t claim their costs of travelling to their office every day – the rules are similar here.
What about Entertainment
When you buy coffee or lunch for a business contact this is generally ‘entertainment’. This can go through your business but is not deductible for tax purposes. A note of who you entertained and what you discussed should be retained.
How do I pay myself?
As a sole trader/self-employed individual, it is simply a case of transferring money to your personal account. These are classed as ‘drawings’.
How much should I set aside for tax?
This is a tough question as so much depends on profits and circumstances but there are some good guidelines.
As a sole trader/self-employed individual, a good amount to put aside is around 25%.
This helps account for the situation of having to pay for payments on account and national insurance. You will pay tax on anything over ~£12k (at 20% to begin with) and National Insurance on anything over around £8.5k (at 9%). These are very rough guidelines. If you start to earn profits of over £50k this will not be enough. When you reach that stage its probably time to have ‘gone limited’!
How do I prove my income for benefits / mortgage?
You provide what is known in the industry as ‘SA302’s’ – this is just your tax calculation from your tax return. Many lenders will want 2-3 years of these and will average profits over the 2/3 years. This can be a little tough if you have only been trading for one year, but you should speak to a mortgage broker as you will still have options.
For benefits the ‘gross’/’taxable’ income is at the top of the calculation as well. A little like employed salaries (‘I’m on £25k a year’) are quoted gross, your gross income will be at the top of the calculation, before tax.
What do I do about pension?
If you have existing pension arrangements it is worth seeking out an independent financial advisor (IFA) to give you some guidance.
In tax terms, you could contribute to a personal pension and will generally get tax relief. This is added at 20% to your ‘pot’. If you are a higher rate taxpayer (you earn over around £50k a year) you will be due some further tax relief and often results in a repayment of tax. This claim is normally done in a tax return.
Where can I get support? Are there groups I could join?
In most industries there are Facebook Groups. LinkedIn can be hit or miss for groups. Always double check any ‘advice’ given out in these groups surrounding tax. There are also differences in tax rules between people operating a Limited Company and you as a Sole Trader, so bear this in mind.
You can check out our blog, YouTube and social media for tax updates. Sig up to our mailing list too, to receive updates to your inbox.
Do I need an accountant? If so, how do I choose one?
UK tax law is ~22,000 pages and changes daily, depending on what happens in the courts (tax tribunals). For this reason, up to date advice and guidance is key to making sure what you are doing is correct. That aside, a good accountant will pay for themselves in the tax savings and save you time and worry. In addition, their fee is tax deductible!
As a sole trader/self employed individual it is definitely possible to register and complete your own tax return. The largest consideration is if you want to – or have time to spend doing this.
In terms of choosing one, you should check out a video and blog here.
In terms of pricing and service, accountants vary wildly. Like most things in life, you generally get a better, more proactive service (and therefore usually save more tax) from the ones that charge more. Do your research.
The quickest way to increase your income? Pay less tax….
If you would like further help on any of this, please get in touch with our team – we’d love to help.