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How much tax will I pay?

According to the Centre for Entrepreneurs, 663,272 new businesses were registered in the UK in 2018. Some people start their own business to earn more money, while others seek more freedom and flexibility, often so they can better balance work and family commitments.

Some people start their own business because they want to be their own boss, so they shape their own destiny. Working for yourself can be much more fulfilling and rewarding, although an easier life isn’t assured, because running your own business brings with it additional responsibilities and pressures.

When many people are considering whether to become a sole trader, a key question is – how much tax will I pay? Answering this can help them decide whether working for themselves will make them better or worse off.

Do I need to pay Income Tax?

If you’re self-employed, you pay Income Tax on your taxable profits (i.e. your total income minus allowable business expenses, allowances and any previous losses, if applicable). However, you don’t pay Income Tax on your first £1,000 of income earned from self-employment, as this is your “trading allowance”.

The current (2019/20) standard Income Tax Personal Allowance is £12,500. You do not pay income tax on this unless you earn more than £100,000. The basic rate of income tax (20%) is payable on earnings between £12,501 and £50,000; a higher rate of 40% is payable on earnings of £50,001 to £150,000.

The additional rate of income tax (45%) is payable on earnings over £150,000 (tax bands in Scotland are different). To reduce your tax bill, you may be able to claim Income Tax reliefs.

What about National Insurance contributions?

Sole traders pay National Insurance contributions (NICs) so that they qualify for some benefits and the State Pension. To pay NICs, as a sole trader, you must make a profit of £6,365 or more a year (threshold correct for 2019/20).

As explained on government website gov.uk: “You usually pay two types of National Insurance if you’re self-employed:

  • Class 2 if your profits are £6,365 or more a year and
  • Class 4 if your profits are £8,632 or more a year

“You work out your profits by deducting your expenses from your self-employed income.”

For tax year 2019/2020, Class 2 NICs are £3 a week, while Class 4 NICs are:

  • 9% on profits between £8,632 and £50,000
  • 2% on profits over £50,000.

You report tax due on the profit you make as a sole trader when you file your Self-Assessment tax return.

How do I pay Income Tax and NICs?

Each tax year runs from 6 April to 5 April, regardless of when you started your business. The deadlines for paying your tax bill are: 31 January for any tax you owe for the previous tax year (known as a “balancing payment”) and your first payment on account; and 31 July for your second payment on account.

After your first full year of business, as well as paying tax for the tax year that’s just ended, you must pay tax for the current year in two installments ( called payments on account). These are advance payments towards your tax bill (including Class 4 NICs, when you’re self-employed).

As explained on gov.uk: “Each payment is half your previous year’s tax bill. Payments are due by midnight on 31 January and 31 July. If you still have tax to pay after you’ve made your payments on account, you must make a ‘balancing payment’ by midnight on 31 January next year”.

Your NIC Class 2 payments are collected via your payroll/PAYE.

What’s the difference between gross and net pay?

Gross pay simply means earnings before taxes and deductions. Net pay is your “take home” after taxes and deductions.

Do I need to pay VAT?

VAT is a transaction tax levied when most goods and services are sold. VAT-registered businesses charge VAT on VAT-able goods or services and can reclaim VAT they’ve paid on products and services they’ve bought.

You can only charge VAT if your business is VAT-registered. If your sales exceed the taxable turnover threshold – £85,000 a year until at least 2022  – your business must become VAT-registered. You can only apply to deregister if your VAT taxable turnover goes below £83,000 a year.

The standard rate of VAT is 20%, but there is a reduced rate of 5% for some goods and services, while others are zero-rated (eg most food and children’s clothes). Visit gov.uk to find out the VAT rate for specific goods and services

Via a VAT return, which usually must be filed each quarter, VAT-registered businesses must report to HMRC all VAT they’ve charged and paid. If more VAT has been charged than paid, the difference must be paid to HMRC. If more VAT has been paid than charged, you can reclaim the difference.

What if I later form a private limited company?

Before its financial year-end, the company must prepare full (“statutory”) annual accounts, as well as a Company Tax Return, so that it’s Corporation Tax liability can be calculated and paid. The Corporation Tax rate payable on company profit is 19%. A company may be able to claim allowances and reliefs to reduce its Corporation Tax bill.

You must pay your Corporation Tax bill nine months and one day after the end of your accounting period (usually your financial year), but you may have two accounting periods in the year you set up your company. 

As well as being a director, you’re a company employee, so you must pay Income Tax through the company’s PAYE scheme. Tax is also payable on dividends paid to company directors.   

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