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Getting to grips with tax
Getting to grips with tax
January 2022
As well as all the exciting and rewarding parts to starting your own business, there is also the tricky bit of understanding what tax and national insurance you’ll have to pay. It’s important that you have a basic grasp of the topic so you can manage your finances properly.
Your tax bill will depend on what type of business you set up. For instance, there are differences between being a sole trader and a limited company, which we briefly cover in our article, ‘Different types of UK businesses explained.’. But for now we will just concentrate on the rules for a sole trader.
Sole traders and tax
Calculating your own tax returns can be a bit complicated. You might benefit from getting an accountant to do this for you, but you do not legally have to.
As a sole trader you would pay ‘Income Tax’. Your income is calculated by deducting allowable expenses from your revenues.
You may not need to pay tax on every pound of income as you will be entitled to a tax-free allowance. And, there are different rates of tax for increasing bands of total income.
| If your income is between: 0 - £12,570 |
Pay zero tax on income within this band. This is known as your tax-free personal allowance.* |
| If your income is between: £12,571 - £50,270: |
Pay 20% of earnings that fall within this band.
This is known as basic rate tax. |
| If your income is between £50,271 - £150,000: |
Pay 40% of earnings that fall within this band. This is known as higher rate tax. |
| If your income is: over £150,000: |
Pay 45% on earnings that fall within this band.
This is known as additional rate tax. |
* Personal allowance drops by £1 for every £2 of income over £100,000.
Please note: these figures are based on tax rates and allowances for England, Wales and Northern Ireland for financial year 2021/22. Different figures apply to Scotland. For up to date information visit HMRC.
So, remember you don’t pay income tax at the same rate across all your income. You only pay the relevant rate of tax on that part of your income that falls within each income band. Let’s look at an example where a sole trader has income of £63,000. His income tax bill is as follows:
Income Band |
Tax-free personal income |
Income Band |
Amount of earnings within this band = £50,270 less £12,571 = £37,699 |
Income Band |
Amount of earnings within this band = £63,000 less £50,271 = £12,729 Total tax payable = £0 + £7,539.80 + £5,091.60 = £12,631 |
We know this can be a bit daunting if numbers aren’t your thing, but you can find more information at the HMRC site, or from an accountant.
And whether you decide to work out your tax yourself or seek help, ALWAYS ALWAYS ALWAYS keep a record of your sales and expenses throughout the year. When it comes to filling out your Self Assessment form you don’t want to rely on memory.
Sole traders and national insurance
National insurance is a system of contributions you pay to qualify for certain benefits, like state pension. If you are self-employed as a sole trader you will need to pay National Insurance Contributions (NIC).
Self-employed individuals will need to pay both Class 2 and Class 4 NIC. The calculations for this are different to income tax, but it does use a system where again your income is split into different bands.
Class 2 NIC If income is below £6,515: |
No NIC payable |
Class 4 NIC If your income is between 0 - £9,569: If your income is between £9,569 - £50,270: If your income is over £50,270: |
No NIC payable
Pay 9% of earnings that fall within this band
Pay 2% of earnings that fall within this band |
Please note: these figures are based on NIC rates for 2021/22. For up to date information visit HMRC.
So, let’s have a look at our sole trader in the previous example who earned £63,000 income across a 52-week year and calculate his NIC.
Class 2 NIC
Income is above £6,515 |
Pay £3.05 x 52 weeks = £158.60 |
Class 4 NIC
Income Band
0 - £9,569: |
No NIC payable |
| Income Band £9,569 - £50,270: |
Amount of earnings within this band = £50,270 less £9,569 = £40,710 NIC payable = £40,710 @ 9% = 3,663.90
|
| Income Band over £50,270: |
Amount of earnings within this band = £63,000 less £50,270 = £12,730
NIC payable = £12,730 @ 2% = £254.60 Total NIC payable = £158.60 + £0 + £3,663.90 + £254.60 = £4,077 |
Phew! As you can see income tax and national insurance contributions can make quite a dent in your bank balance. So, it would be a good idea to put some cash aside from each sale to ensure you can meet your tax and NIC bill at the end of the year.
QUICK FIRE REMINDERS FOR SOLE TRADERS
You have to pay income tax and NIC
Income = revenue less allowable expenses
You pay no income tax on income less than £12,570
Keep invoices and receipts
Put money aside throughout the year
Check HMRC for latest rates and allowances
Let’s talk. We’re Britain’s bank for small businesses. Our Business Banking experts are here to help you with your business, with 25 months’ free day-to-day business banking, as well as 1 year’s free expert business advice from Enterprise Nation. Call 0345 835 3858 or contact us via your business bank account.
