As a sole trader, you work for yourself and own every penny you make. In the eyes of the law, you and your business are one and the same. Initially, this sounds pretty straightforward. However, this can sometimes lead to confusion regarding:
a) What to pay yourself
b) How to pay your taxes
You might be wondering why you need to pay yourself at all. After all, you and your business are joined in holy financial matrimony and sharing all things. Here’s the thing, though: when Self-Assessment season rolls around, you’re going to want comprehensive records of every single transaction you make for your business.
To pay yourself, you’d withdraw money from your business bank account to your personal account as ‘drawings’. It’s vital that you keep a record of any drawings you take from your business, as this can impact your cash flow and business profits. Income Tax and National Insurance contributions are paid based on the profits your business makes. Essentially, the lower your profits are, the less tax you pay!
Note: If you’re a limited company director, you’ll want to follow a different process for this. Don’t worry - we’ve written you your own personal handbook to help you out!
How Do I Pay Myself From My Business?
The first step is to open your own business bank account. If you haven’t gotten around to this yet (or aren’t sure it’s necessary) read our guide on the topic for advice on getting started.
In short: it’s crucial to keep your personal and business finances separate. Having all transactions come in and out of the same account makes it difficult to keep track.
Once you’ve opened a business bank account, you can simply transfer money from this account to pay yourself. Remember to keep a record of these drawings, along with any other business incomings and outgoings. Take care of your books by keeping them neat and up-to-date, and they’ll take care of YOU once tax season comes around.
How Do I Report My Profits to HMRC?
As a sole trader, you’ll need to complete a Self Assessment every year to declare your business profits. In this case, your profits are calculated by subtracting allowable business expenses from your total annual income. For this reason, it’s important to check you’re claiming everything you possibly can. The lower your final profit margin is, the less tax you’ll have to pay.
Keep in mind that expenses need to be “wholly and exclusively used for business purposes”. Anything personal expenditures aren’t going to count against your total (including those new AirPods you’ve been eyeing up).
How Much Should I Put Aside to Pay My Taxes?
While lower profits equal lower taxes, the reverse is also true. The higher the reported profit, the higher your tax liability.
Unlike PAYE, where tax is deducted before you get the income, self-employment means you pay what’s due at the end of the year. The best way to prepare for this is to set aside a percentage of each payment you receive for tax. That way, you’re guaranteed to have enough money to cover your Self-Assessment tax bill.
Here’s our recommended scale to show exactly how much you should set aside for annual Income Tax and National Insurance:
Profits per annum
% set aside for tax
Up to £50,000
Up to £100,000
For example, if your business has an annual profit of £80,000, then you should set aside £32,000. While you might not pay that much, it’s better to have too much set aside than not enough. And if you end up paying less, you’ve got a nice little bundle to spend (or invest, or save - it’s up to you what you do with it, really). Enjoy!
Do I need to declare my earnings from employment or dividends?
While your business is still in fledgling mode, you might be working for an employer while you get your hustle going. This is perfectly legal - as long as you declare it.
If you’re getting a wage from an employer, you need to mention this in your annual Self Assessment. The good news is that you won’t have to pay Income Tax and National Insurance. That’s because this is usually already deducted through the Pay As You Earn (PAYE) scheme. So that’s one less thing to worry about!
Your employer will give you a P60 Form at the end of the tax year, which details your income and taxes paid. Include the income tax that has already been deducted from your employer on your Self Assessment, and HMRC will calculate any additional Income Tax and National Insurance due from your self-employment. Don’t worry - you won’t be double taxed.
If you have any other sources of income - such as dividends from a company or rent from a property - you must declare this on your Self Assessment as well. Once you do this, HMRC will calculate the tax owed and let you know the total.
How and When do I Have to Pay HMRC?
Your Self Assessment should be filed online, and any taxes due must be paid to HMRC before 31 January after the end of the tax year (Note: The tax year runs from 6 April to 5 April the following year). It’s always better to get in early to avoid any late penalties (which start from £100 - steep). If you’re looking for helpful tips to get a jump on things, you can check out our Self Assessment FAQs guide.
If your tax bill is more than £1,000 for the year, you’ll need to make ‘Payment on Account’. Basically, this means you need to pay forward half of your total expected tax bill for the following year. This might seem unfair, but its HMRC’s way of making sure that taxes are paid regularly.
The good news? You can do this in installments. There are two payments made towards the Payment on Account. The first must be made by 31st January and the second payment is due on (or before) the 31st July each year.
If it’s your first time filing a Self Assessment as a sole trader, this means you have to pay your tax bill for the year filed, plus an extra 50% for the following tax year by 31st January. This evens out after the first year. Some sole traders find it easier to budget this way by spreading the tax payments out instead of tackling one large lump sum.
After that, you’re in the clear!
Want Some Help with That?
As a sole trader, filing your own Self Assessment for the first time can feel like a nightmare. What expenses you can claim, maintaining your books, making sure you pay your taxes on time - it’s overwhelming. We know - we’ve been there!
Addition offers full-suite financial services to small businesses and startups - from bookkeeping to growth funding. Our tailored plans grow with your business, eliminate the need for a full-time finance team, and give actionable insights to get you further, faster! Hop on a call and let us make it all add up!