If you’re thinking about becoming self-employed, you’ll want to understand how much of your income you may need to set aside for tax.
The amount you pay will depend on factors including your business profits, other income and personal circumstances. This guide provides an overview of the main taxes you may need to pay as a sole trader and links to more detailed guidance to help you work out your tax bill.
Do I need to pay Income Tax?
If you’re self-employed as a sole trader, you’ll normally pay Income Tax on your taxable business profits, rather than on your total sales or turnover.
Your taxable profit is broadly your business income less allowable business expenses and any other relevant deductions or reliefs. Your business profits are then considered alongside your other taxable income when working out how much Income Tax you need to pay.
The amount you pay will depend on your total taxable income, available allowances and the Income Tax rates and bands that apply to you. Different Income Tax rates and bands apply in Scotland.
If you’re self-employed, you may also need to plan for National Insurance contributions (NICs).
Depending on the level of your profits, you may have to pay Class 4 National Insurance. If your profits are below the level at which your National Insurance record is protected automatically, you may also be able to make voluntary Class 2 contributions to help protect your entitlement to certain benefits and the State Pension.
The amount of National Insurance you pay is based on your self-employed profits and is normally calculated and paid through Self Assessment, alongside any Income Tax due.
If you’re self-employed, your Income Tax and any Class 4 National Insurance due are normally calculated through Self Assessment.
The tax year runs from 6 April to 5 April. You’ll normally need to pay any tax you owe for the previous tax year by 31 January following the end of that tax year.
You may also need to make payments on account towards your next Self Assessment bill. These are advance payments based on your previous tax bill and are normally due in two instalments:
31 January – first payment on account
31 July – second payment on account.
If your payments on account don’t cover your final tax bill, you’ll usually need to make a balancing payment by the following 31 January.
Not everyone has to make payments on account, so you should check the rules that apply to your circumstances.
Does it matter how much money I take out of my business?
If you’re a sole trader, the amount of money you take out of your business for personal use doesn’t determine how much Income Tax or National Insurance you pay.
Instead, these are based on your taxable business profits, together with any other relevant income you receive. Money you take from the business for yourself is known as drawings and isn’t a business expense that reduces your taxable profit.
Do I need to pay VAT?
VAT is a tax charged on many goods and services. If your VAT taxable turnover exceeds the VAT registration threshold, you’ll normally need to register your business for VAT. You can also choose to register voluntarily in some circumstances.
Once registered, you’ll normally need to charge VAT on taxable sales, keep VAT records and submit VAT returns. You may also be able to reclaim VAT paid on eligible business purchases.
VAT is separate from the Income Tax and National Insurance you pay on your business profits, so it’s important to account for it separately when managing your finances.
If you later decide to operate through a limited company, the way the business and its owner are taxed changes.
A limited company is a separate legal entity and normally pays Corporation Tax on its taxable profits. The company will also have its own accounting, tax filing and payment responsibilities.
As a director, you may receive money from the company in different ways. For example, salary may be subject to Income Tax and National Insurance through PAYE, while dividends are subject to separate dividend tax rules and aren’t subject to National Insurance.
The tax consequences of operating through a limited company can therefore be quite different from being a sole trader. Tax is only one factor to consider when choosing a business structure – you’ll also need to consider matters such as personal liability, administration and reporting requirements.
