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The Complete Guide to Filing Your Taxes as a Sole Trader

Gary Green
Gary Green
June 17, 2021

The simplest and most straightforward way to open a business is as a self-employed person in your own name called a “sole trader”.

As a sole trader, either on your own account or in partnership, you run your own business as a self-employed entity.

A sole trader needs to ensure they are registered with HMRC and this can be done via the CWF1 form online and then you must file a tax return annually. They may also need to register and account for VAT if your turnover goes above the VAT registration threshold, currently £85,000, or voluntarily if there is a benefit to recover VAT and your customers do not mind you charging them VAT.

This allows for a relatively easy setup in the early years of a business. A self-employed individual effectively treats both their business and personal tax affairs in one, with profits treated as income and taxed accordingly.

Pros of a Sole Trader Setup

  • Low set-up and running costs compare to other options.
  • Relatively straight forward tax returns (using Self Assessment).     
  • You can take on employees like any other business.

Cons of a Sole Trader Setup

  • You are personally liable for any business losses which could place your own assets such as your home at risk. Dependant on the business you are starting up, this can create a significant amount of risk.
  • Can be hard to raise finance.
  • Not seen as prestigious as other business types.

Registering for Self Assessment

If you need to complete a Self Assessment return for the first time you should inform HMRC as soon as possible. The latest date that HMRC should be notified is by 5 October following the end of the tax year during which you became self-employed. There can be penalties if you register late (or fail to register).

National Insurance

Sole traders are also required to pay Class 2 and 4 National Insurance Contributions (NICs) on all taxable business profits.

This includes in the current 2020-21 tax year:

  • Paying Class 2 NICs – at a fixed rate of £3.05 per week unless your annual profits are less than £6,475;
  • Paying Class 4 NICs – at a rate of 9% on profits between £9,500 and £50,000 and 2% on profits above £50,000.

VAT registration

As a sole trader you will also be required to register for VAT if you meet either of the following two conditions:

  1. At the end of any month, the value of your taxable supplies made in the past 12 months or less has exceeded £85,000; or
  2. At any time, there are reasonable grounds for believing that the value of your taxable supplies to be made in the next 30 days alone will exceed £85,000.

Paying HMRC

As a sole trader, the income and profits from your business are reported to HMRC using the Self Assessment process. This means that you will need to complete a Self Assessment tax return every tax year (e.g. from 6 April 2021 – 5 April 2022) detailing your sole trader income and expenses.

If you have other income this will also need to be declared on your annual Self Assessment tax return. Your Income Tax liability will be based on your total taxable income less any personal allowances and allowable deductions. Note, tax relief is given to sole traders for expenses incurred wholly and exclusively for the business.

Your Self Assessment return, must be filed and all taxes you owe must be paid before the 31st January each year e.g for the tax year ending 5 April 2022, the return and payment must be paid before 31 January 2023.

Payment on account

If your tax bill is more than £1,000 for the year, you will usually be required to make a Payment on Account.

Sole traders are usually required to pay their Income Tax liabilities in three instalments each year. The first two payments are due on:

  • 31 January during the tax year e.g. for 2021-22 the first payment on account is due on 31 January 2022.
  • 31 July following the tax year e.g. for 2021-22 the second payment on account is due on 31 July 2022.

These payments on account are based on 50% each of the previous year’s net Income Tax liability. In addition, the third (or only) payment or repayment of tax will be due on 31 January following the end of the tax year e.g. for the 2021-22 tax year a final payment is due imminently on 31 January 2012.

You can request a reduction in your payment on account if your income has fallen. However, if your taxable profits have increased there is no requirement to notify HMRC and increase your payments on account.

Record keeping

If you are self-employed as a sole trader then you must keep suitable business records as well as separate personal records of your income.

For tax purposes, the business records must be held for at least 5 years from the 31 January submission deadline for the relevant tax year. For example, for the 2021-22 tax year where online filing was due by 31 January 2023 you must keep your records until at least the end of January 2028. In certain situations, such as when a return is submitted late, the records must be held for longer.

If you are self-employed you should also keep a record of:

  • all sales and income
  • all business expenses
  • VAT records if you’re registered for VAT
  • PAYE records if you employ people
  • records about your personal income

You should also ensure that you keep your business records and your personal records separate. There are penalties for failing to keep proper records or for keeping inaccurate records.

Expenses

Sole traders can claim back any expenses they have incurred that relate directly to their business in much the same way as limited companies. As mentioned above, the expenses must be ‘wholly' and 'exclusively' incurred in the performance of their duties.

The self-employed can claim tax relief for allowable expenses incurred as part of running their business. The costs of allowable expenses will be deducted from taxable profit. HMRC’s guidance is clear that allowable expenses do not include money taken from your business to pay for private purchases.

Costs you can claim as allowable expenses include:

  • office costs, for example stationery or phone bills
  • travel costs, for example fuel, parking, train or bus fares
  • clothing expenses, for example uniforms
  • staff costs, for example salaries or subcontractor costs
  • things you buy to sell on, for example stock or raw materials
  • financial costs, for example insurance or bank charges
  • costs of your business premises, for example heating, lighting, business rates
  • advertising or marketing, for example website costs
  • training courses related to your business, for example refresher courses

It is important to note that not all expenses in these categories will always be allowable. HMRC will normally allow your claim if you meet the qualifying conditions for the expense. If there is an expense that is for personal and business reasons, then only the business element of the claim is allowable.

HMRC provides the following example: "Your mobile phone bill for the year totals £200. Of this, you spend £130 on personal calls and £70 on business. You can only claim for £70 of business expenses."

Sole traders who work from home can also claim the business proportion of their expenses for costs incurred in running their home, such as heating and electricity. There are also some simplified expense rules available for claiming a fixed rate deduction for certain expenses where there is a mix of business and private use. The simplified expenses rules are not available to limited companies or business partnerships involving a limited company.

The use of flat-rate expenses for core business activities carried out from the home saves having to calculate the proportion of personal and business use for certain bills in the home. Usually, this applies to various utility bills. Instead, a monthly deduction is allowable. The use of the simplified expenses regime is optional, and businesses can instead claim the trade proportion of actual costs.

If you have any questions about the issues raised in this article, we at Key Business Consultants can help. Get in touch with us today or call us directly on 02037 282 848.

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