If you are a sole trader, then you are not employed directly, which means that you are not receiving any type of salary or wage in a traditional way. So, as a sole trader, how can you pay yourself and your tax due. The personal drawings that you took from the business can be considered as your payment. Also, the amount that you have to pay for your National Insurance Contributions and Income Tax will likely depend on the profits.
Hence, it is important that you should keep a record of all the personal drawings that you obtain from your business to pay yourself. This is very valuable when updating your bookkeeping records and computing your profits, ultimately, you have to pay tax on your profits. That is why you must set aside some money for paying your tax bill. Your tax will be paid when you submit your annual Self Assessment. However, if you are the director of your limited company, then it will be a different situation.
How Do I Pay Myself From My Business If I Am A Sole Trader?
Paying yourself as a sole trader can be done easily, just take some money from your business. However, it is greatly recommended that you should take a separate business bank account for your sole trader finances.
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It is important that you should retain a record of these drawings, as well as any other incomings and outgoings that will come along the way. Nevertheless, you should save some money for the payment of the tax that you owe. Make sure that you can easily access them. It would be a good idea if you can place them on a savings account so it can earn some interest until the time comes that you pay it to the taxman.
If I Am A Sole Trader, How Much Should I Save To Pay My Tax?
If you are a sole trader, then you are taxed based on the profits that your business earns through your annual Self Assessment tax return. Typically, your profit as a sole trader is computed based on the income that your business obtained subtracted by the allowable expenses incurred by your business. Make sure that these expenses are purely intended for business purposes only and do not include any personal expenditure.
Undoubtedly, the greater the amount of your profit, the higher your tax liability will be. Here are some suggestions on how much you need to set aside from your drawings so you can pay your Income Tax and National Insurance liabilities.
If you are earning a profit of up to £50,000, then you need to set aside 25% from this profit for paying the tax. If your profit reaches up to £100,000, then 40% of it should be saved for tax payment. Finally, if your business gained a profit of more than £100,000, then you have to save 45% of these earnings for your tax due.
Are All The Money In The Business Considered Mine?
Legally, as long as you are a sole trader, there is actually no difference between you and your business. You are receiving income from your business and paying all your expenses including your tax liability which you need to pay as an individual. Sometimes this can be a bit complicated to handle since there could be a gap from receiving your income to paying the tax you owe for the profit of your business.
What Will Happen If I Also Have Some Income From Employment Or Dividends?
If you obtained some earnings from employment or from being self-employed, then you must show this on your annual Self Assessment tax return. Your employer must have probably deducted your National Insurance and income tax due through the Pay As You Earn (PAYE) scheme.
For more information on this, you can refer to the form that your employer will provide at the end of each year, also known as Form P60. On your Self Assessment, you must incorporate the income tax that was deducted by your employer for the same tax year. Furthermore, HMRC will compute if there are any additional income tax or Self-Employed National Insurance due.
Likewise, if you have acquired any dividends from any company or any other additional income such as from property, then you should incorporate them on your Self Assessment and HMRC will compute the tax you owe.
How Are My Profits Reported To HMRC And How Do I Pay?
Each tax year, your profits will be reported to HMRC, through your Self Assessment Tax Return. They will compute your NICs (National Insurance Contributions) and income tax so you will be aware how much you are going to pay for your final tax bill. You will file your Self Assessment and pay all the taxes that you owe before January 31st every year. If not, then HMRC will charge you with penalties starting from £100.
In case, for a particular year, your tax bill reaches to more than £1,000, then you have to make a Payment on Account. In this way, HMRC can ensure that tax is paid regularly and it is directed towards your succeeding Self Assessment. When you are on Payment on Account, you have to make two payments. The first payment should be done on January 31st and the second payment should be made on or before July 31st each year.
If you think that you won’t earn a lot of sole trade profit in the succeeding tax year, then you should discuss this with HMRC and perhaps you might be able to lessen your Payment on Account to HMRC.
You may find that things are much simpler with a sole trader compared to a limited company, however, it would be much easier if you will use online accounting software so you can monitor all of these and prepare yourself when filing your Self Assessment (make sure to check out difference between ltd and sole trader ).
Q&A – Tax And NI As A Sole Trader
Q: In case I am having a small side business where I am making a few hundred pounds a month, at what point should I inform HMRC that I am setting up myself as a sole trader so I can declare my additional income?
If you are freelancing on the side, then you should register yourself as self-employed immediately after receiving any income that is not taxed at source. However, you might not be required to pay any tax on your income as a sole trader if your earnings do not exceed £1,000 in a single tax year. The amount for National Insurance or any tax due shall be computed and paid through your annual Self Assessment.
Q: Can I review the annual dates when my Self Assessment should be filed every year? Also, can I get any help in completing my Self Assessment form?
Every year, the tax period is between April 6th and April 5th. Self Assessment should be registered on October 5th, after the end of any tax year where you have received income as a sole trader. Self Assessment should be filed and any tax due should be paid by January 31st after the end of each tax year that it applies to. In case this is not your first Self Assessment, then you might also be required to make Payment on Account by July 31st in the event that your last Self Assessment bill has reached to more than £1,000.
When it comes to completing your Self Assessment, it can be very helpful if you use an online accounting system that includes apps for keeping track of expenses, mileage, as well as importing transactions and bank statements.
Q: If my sole trader income is not more than £6,365 then do I still need to pay any National Insurance (NI) on my sole trader profit, or as what I have understood there is no need of taking any National Insurance (NI) on this earnings during this particular situation?
As we have mentioned earlier, you have to ensure that you are registered as self-employed and have fully completed your annual Self Assessment. Afterwards, HMRC will inform you of the National Insurance and Income Tax that you must pay.
In the event that your sole trader profits fall below the Small Profits Threshold which is £8,365 for the tax year 2019/20 then you will not be obliged to pay any self-employed NI.
Q: Should Class 2 be considered as part of the annual Self Assessment since HMRC has already gotten rid of the monthly, quarterly or half-yearly Direct Debit (DD)?
The computation of Class 2 National Insurance is done weekly however the payment is done as part of your annual Self Assessment. Actually, there is no need for setting up a monthly Direct Debit so you can pay your Class 2 NI contributions separately.
Q: If I am accomplishing a Self Assessment to disclose an additional income from a rental property, do I have the same classification with a sole trader with the additional NI class or not?
No, in case you are only disclosing rental income, then this is not classified the same as a sole trader income, hence you are not required to pay self-employed National Insurance on this income.
Q&A: Setting Up As A Sole Trader
Q: If I want to change my business name at some point, how do I accomplish this? Is the process too complicated?
Actually, it is quite simple if you are a sole trader. All you have to do is change the templates that you use for your invoices and any other pertinent documents. Also, you must inform your clients. You should also update your websites or any other business listings as well. Keep in mind that there are certain rules that you have to follow when it comes to choosing a name for your business.
On the other hand, changing the name of a limited company is quite complicated since you are required to inform HMRC and the Companies House.
Q: What if I am a sole trader working as a graphic design freelancer, do I need any insurance?
It is ideal that you should have one since Small Business Insurance can provide protection to your business, yourself, as well as your clients in case there are unexpected circumstances that will occur. Whether you have hired staff or you are not working in-house, Professional Indemnity Insurance can protect your business against a client who sues you for a financial loss since they believe that it was caused by your neglectful advice and services.
Q: When I started my freelance, I was using one personal account then afterwards I transferred my business finances to my business account, how should I list this in my tax accounts?
The ideal thing to do is you should have at least used a different personal account for your business income before setting up a business bank account. The important thing that matters now is that you have to declare your income from being a sole trader (see sole trader accounting for advice) and present any receipts for your expenses so you can use them to claim as a sole trader. You have to save copies of your receipts, invoices, and some credit card or bank statements, whether it’s business or personal, for a period of up to six years.
Q: I worked part-time for 3 days per week, and belonged to the higher tax bracket while I am completing my Self Assessments. At the same time, I also started doing contract work 1 day each week as a sole trader with limited income. Should I still save 25% of my sole trader income to cover my tax due or will it have the same tax rate as my part-time employment?
If this situation applies to you, then you should probably set aside 40% to cover the tax of your sole trader income since you have already used up your personal allowance as well as the Basic rate band.
Q&A: Expenses As A Sole Trader
Q: I am working from home as a consultant, can I offset my sole trader expenses such as electricity bills?
Absolutely, When working from home, there are a couple of expenses that you can claim. Although it is a bit complicated and it likely depends on whether you have set up yourself as a sole trader or as a limited company. In case you are a sole trader, then you also have the option to choose how you can claim your expenses, whether you use the simplified expenses wherein you can claim a flat rate or claim a proportion of your household bills.
Q: Can business accountancy fees be charged as expenses?
Absolutely, since business accountancy fees can be considered as an allowable expense.