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How do I pay myself and how are my taxes calculated

How are my taxes calculated and how do I pay myself?

As a Sole Trader, you’re taxed on the profits that your business makes. Essentially, your profit is the income that your business receives, minus the allowable business expenses that have been incurred.

These expenses must be purely for business, rather than any personal expenditure. Our general rule of thumb is to keep a third of all income received in reserve for tax liabilities.

How do I pay myself?

As a Sole Trader you do not pay yourself a salary or wage. This is because you do not employ yourself. As such, any payment you make to yourself as an individual must be recorded as a ‘drawing’.  

To take out a drawing on your account:

  • Navigate to Banking - Bank Account - More - Add Transaction.

  • From here select the Type - Money Out - Money Paid to User.

  • Enter the details and leave the Reason as Drawings.  

 How is this all taxed - Surely all the money in the business is mine?

As far as the law is concerned, you and your business are two separate entities and must be kept clear and distinct at all times. You are personally liable for all taxes owed by the business because you are the owner of the business.  

Example:

If you have an Invoice for £1,000.00, with expenses of £200 (remember purely business, not personal) then your total profit will be £800. You are then taxed on that £800, making it your taxable profit.  

Understanding the types of tax charged by HMRC

There are two types of tax charged by HMRC - National Insurance and Income Tax. 

National Insurance (NICs) 

Regardless of your business’ profit, you will need to pay some form of NICs. For most of you, this will be Class 2 & 4 NICs.

Class 2 is a compulsory tax on a sole trader if your profits are over £5,965. This works out to be £2.80 per week and goes towards your State Pension and other benefits

Class 4 is calculated to be 9% of your profit between £8,060 and £43,000; and 2% over £43,000. 

Income Tax

If your taxable profits are less than  £11,500 (17/18) then you won’t have to pay Income Tax through your Self Assessment. This is because HMRC provide a Personal Allowance each tax year, which is the amount you are able to earn before your profit becomes taxable.

 

Tax Rate

Taxable income above your Personal Allowance £11,500

Basic Rate 20%

£0 to £33,500 - You will only pay this rate if over your Personal Allowance (£11,500 is the standard PA for 2017-18)

 

Higher Rate 40%

 

£33,500 to £150,000 - this is charged on income over £45,000  if you have the standard Personal Allowance

Additional Rate 45%

Over £150,00 - Every £2 of income above £100,000 tapers the Personal Allowance of £11,500 down by £1.

 

Worked example when you have sole trader profits

In this example, imagine you’ve made £20,000 in profits for the year.

 
 

Income Tax

 

National insurance

 

Sole trade profits

£20,000

 

£20,000

 

Personal Allowance (2016-17)

£11,000

     

NIC Class 4 Allowance (2016-17)

   

£8,060

 

Taxable income

(after subtracting allowances)

£9,000

 

£11,940

 

Income Tax / NIC

to pay  

20% basic rate tax payer 2016-17

£1,800

9% 2016-17

£1,074.60

Total Tax

     

£2,847.60

 

Your total tax of £2,847.60 will be subtracted from your overall profits of £20,000. This leaves you with a grand total of £17,152.40 in take home pay (also known as income after tax).  

What happens if I have another earning from a salaried job or dividends?

These would be added to your sole trade profits, then income tax is applied to the whole amount. So looking at the example above, if you had a part time job earning £12,000, your total earnings would be £32,000. The personal allowance is then applied to this figure instead, resulting in taxable income of £21,000. 

How is it reported to HMRC and how do I pay?

Your profits are reported to HMRC each tax year via your Self Assessment Tax Return. Your Income Tax and NICs calculations will highlight how much you’ll be paying on your final tax bill. Your Self Assessment must be filed and all taxes you owe must be paid before the 31st January, otherwise HMRC will fine you penalties starting from £100.

If your tax bill is more than £1,000 for the year, you’ll be required to make a Payment on Account. This is HMRC’s way of ensuring tax is paid regularly and it goes towards your next Self Assessment. This must be be paid by 31st July. 

Note: If you have reason to believe that you won’t have as much trade in the next year, let us know as we could potentially argue your Payment on Account with HMRC.

 
Last Updated: 11 Jul 2018 09:57AM BST

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