Sole Trader Tax Guide | Understanding Sole Trader Taxes

If you are a business owner, then you can be said to be working in what is commonly known as a sole trader. In simple terms, a sole trader is an individual business where one person makes all the decisions and at the same time run the business.In this article we shall discuss about sole trader tax and how much tax do i pay as a socle trader.

What is a Sole Trader?

A sole trader is an individual engaged in any trade or activity on his or her own. For example, you could be a painter, a plumber, a tutor, or even a freelance writer as there are a lot of opportunities to chase your hobbies. You do not have a superior.

Sole Trader and Tax: What You Need to Know

As a sole trader it work differently than other people employed by companies. When you work for a company the company is deducting tax from your wage, before you receive your wage. Whereas with a sole trader, one work out their own tax and pay it for the government.

You also must know how much money your business makes and how much money you spend to make the business successful. This assists you in determining your liability to tax.

How Much Tax Do I Pay as a Tax Sole Trader?

There is very important question is arises among the people: as a sole trader how much tax do i pay, To determine your profit, you need to eliminate your business expenditure from your income. For instance, if your business generates £50000 within one year, but get £10000 spent on items such as equipment, rent and stock, then your profit is £40000. This is what you deduct tax on, profit solely based on what you get from the business, from sales.

Income Tax for Sole Traders

Income tax is calculated based on the number of income” fees you have to pay depending on the amount of money you earn. In the UK, there are various levels, known as tax bands. The overall idea is that the individuals with higher income earn a greater percentage of tax.

Here’s a simple example of how income tax works:

You will not pay any income tax on your profit if your profit is up to £12,570 because this is your personal allowance. All citizens of the UK receive this amount free from tax.

Despite its complexity, the bands are very simple as the tax is 0% on the first £12,570 and 20% on the remainder of income up to £50,270.

For income over £50,270, the tax credit is 40% of the income above this figure.

For instance, let it be that you earn £40,000 in benefit. The first £12,570 is tax-exempt in this system. The next £2,000 that you earn will cost you £4,000 accounting for national insurance at £248 leaving you with £520 tax free or will cost you £2,000 excising income tax on the rest, which amounts to £5,486.

National Insurance Contributions (NICs)

As a sole trader you are obliged to make a contribution to NICs. NICs are those revenues through which the UK’s healthcare (NHS) and state pension expenses are financed. There are two classes of NICs for sole traders:

Class 2 NICs: These are small, fixed payments if your profits are more than £12,570 a year. It is more often set at £3.45 per week.

Class 4 NICs: These are based on your profits and includes The Cost of Goods Sold, Gross Profit, Operating Profit and Net Profit. The next band is between £12,570 and £50,270 where you pay 9% of the company’s profits and you pay 2% of profits over £50,270.

For example, if you incurred a profit of £40,000, then the Class 4 NICs would be £2,477.70 combined with £179.40 for Class 2 NICs.

Sole Trader Tax: Keeping Records

In order to calculate the correct amount of tax which has to be paid when you are a sole trader you must record all the income and expenses you get during trading. You should track:

Income: Amount of cash your business receives from the sale of goods or services it offers to clients.

Expenses: The equipment or other items that are used in the operation of the business but are not directly involved in creating or buying a product. The expense increase your cost and thus decrease your profit to a level that you will pay less tax.

This requires one to be very organized, and to do this he or she needs to have some important qualities as highlighted below. Some of the tools that many sole traders employ in their businesses include accounting software to ensure orderliness.

Finally, after every year of trading, you will be required to complete a Self Assessment tax return. This is the way people declare their income and expenditures to the British tax service, known as HMRC, and learn how much money they are to pay to the state.

Filing a Self Assessment Tax Return

Self-employed individuals are required to complete a Self Assessment tax form each year. This is a formal document used to inform the government of your income level and your business expenses. This must be done even if one does not owe any tax, as it is mandatory to do so.

The process is simple:

Register as a Sole Trader: First of all, one has to formally register at HMRC as a sole trader.

Keep Records: You should maintain all the financial records that you come across for the whole year.  

Complete the Tax Return: Self Assessment tax returns are due by April 5th of the fiscal year, and must be processed via the online account or on paper filled out by an individual. 

Tax Payment: After filing the return, the taxpayer is informed by HMRC of the taxes and National Insurance Credits to be paid. This sum must be paid by the taxpayer by January 31st bearing the next year. 

In situations where such knowledge is lacking, it is permissible to ask for the help of an accountant or a bookkeeper.

How to Reduce Your Sole Trader Tax

However, the following are some legal ways in which it is possible to minimize tax for those who are sole traders. These include:

Claiming business expenses: If you had to spend any amount of money to fund your business then that amount can be subtracted from your total make. This reduces the fraction of profit subject to tax.

Using Tax Free Allowence: In addition to the personal allowance, one can find other allowances, such as the trading allowance. As a result, you can make money for a business without the need to pay tax on the profits up to 1,000 pounds.

Pension contributions: For this reason, these have the effect of lowering your tax obligation because the money put into a pension plan is deductible from taxes.

How Much Tax do I Pay as a Sole Trader?

The income earned by a self-employed individual is subject to income tax and National Insurance levies. The actual amount will be determined by the level of profit made by a sole trader’s business. You are required to file a self-assessment tax return every year, aside from paying sole trader taxes, to declare the amount you made that year.