What you should know if you are a sole trader or self-employed

If you are in business for yourself you are a sole trader or self-employed.  Both terms have the same meaning (both are used in this blog but mean the same thing).  You are a sole trader or self employed if you are not in partnership with anyone else and you have not set up a limited company.  If you had set up a limited company you would be employed by that limited company and be a director of it.

When someone decides to start a business they will most often be a sole trader.  This gives them chance to see how the business develops before deciding whether to become a limited company or go into partnership with someone.  It is more straightforward to set up and, if things don't work out, is easier to shut down.

Being in business means receiving money from customers for services you provide or goods you purchase and sell on.  

Register with HMRC

Once you are self-employed you must notify HMRC because you will need to complete a tax return after the end of each tax year.  The tax return will report the income and expenses from your business and calculate any tax due on the profit.  You will also need to report other income on the tax return such as employed earnings, share dividends or interest earned.

Your earnings

As a sole-trader you don't receive a wage as you would if you were employed by someone else or if you were a director in your own limited company.  You will take drawings from the company which are not an expense of the company.  Drawings do not reduce the profit you make and neither does the tax you have to pay.

All the profit you make in your business each year belongs to you but you will have to pay tax on any amount over the tax threshold (currently £12,570 in 2022-23).  You should therefore always be aware of the profit you are making to ensure you are not personally taking more than the amount which is left after tax.

Business bank account

Sole traders should always separate their business income and expenses from their personal income and expenses.  Muddling them up makes it much more difficult to identify how much income your business is bringing in, what it is costing you to run and how much you are spending personally.

We see so many sole traders using their business account as a personal bank account as well as setting up business direct debits on their personal account.  By doing this business costs could easily be missed when calculating the profit and your business bank account will never reflect how your business is doing.

And if HMRC decide to check your records they will want access to all your bank accounts.

Always separate business and personal spending, drawing one regular amount weekly or monthly for your personal spending to your personal bank account.

Managing your accounts

Keeping track of your income and expenses accurately using accounts software means that you will always know what your profit is and therefore how much money could be yours to draw from your business.  You might think that your bank account balance tells you that - it doesn't!

Accounts software will draw in the transactions from your bank and you can quickly allocate them.  As long as this is done accurately and consistently you will be able to produce an income and expense (Profit & Loss) report showing you how your business is doing.  From this you will be able to identify how much money you can take from your business.  The current tax threshold (2022-23) means that you can take £1,048 of your profit each month without it being taxable, but you will pay National Insurance Contributions on any amount you take above £992.33. per month.  

Taxes

Income tax and National Insurance Contributions are calculated on your profits for the year which have been submitted through your tax return.  Your tax return is done online and the calculation is completed for you before submission so you know how much you will have to pay.  Tax is payable by 31 January and 31 July each year.  Your first tax return and payment won't be due until 31 January after your financial year has ended.  So if your accounting year is 1 April 2022 to 31 March 2023, your tax return and first payment will be due by 31 January 2024.  It makes sense to submit your tax return as soon as possible after the end of your accounting year so you know how much tax you will have to pay.  

Your first payment at 31 January will be the total tax due for your accounting year plus 50% in advance for the next accounting year (which you have already completed 9 months of).  The payment due at 31 July is the 50% balance so that all the tax due for accounting year you have just completed will have been paid and in January you will pay any balance which is due if you have made more profit plus 50% in advance for the next year.

It is really worth getting your first tax return in as soon as possible after your year end because you will probably have a larger tax bill than you expect as you will be paying tax in arrears as well as in advance.

Do you need some help?

We work with lots of sole traders keeping their accounts up to date so they know exactly where they are with their income and expenses.  We track the income when it is getting near to the VAT registration threshold so that you are kept informed and can decide whether to continue to grow your business or cut back.  Being VAT registered is straightforward when you have us managing it for you so it isn't something to shy away from.

Using accounts software may be challenging for you but we use it all day every day.  You can learn to do it yourself but having someone with experienced to do it for you saves you time and will definitely give you peace of mind.   We provide businesses with regular reports showing how their business is doing.  It also helps to have someone on your side for advice and guidance when you need it.

If your 2023 resolution is to get some help, contact us.  One of our friendly and helpful bookkeepers will get your accounts on track and support your business in its growth.  Give us a call on 01722 341820.