Income tax
Sole traders must pay income tax on the profits they make. Profits are calculated, broadly, as yearly income minus allowable expenses. Examples of allowable expenses may include costs of travel, staff, finance, office equipment and business premises. To be allowable, however, expenses must be incurred wholly and exclusively for business use. If a sole trader works from home, a portion of its related costs (such as bills and rent) may qualify as a deductible business expense. A guide to allowable expenses for those who are self-employed is available here.
Sole traders may benefit from reliefs which could reduce their income tax liability:
- A sole trader may be able to reduce the income tax payable on their business profits by claiming capital allowances relief in respect of the purchase of certain kinds of business assets. Capital allowances are described in more detail here.
- Depending on the amount of taxable income received by a sole trader, they may be able to use their personal allowance (described above) to reduce their liability to income tax.
- If a sole trader earns only a small amount of trading income, he/she may choose to apply the “trading allowance”. Where the trading allowance applies, sole traders would not have to pay income tax on the first £1,000 of trading income. However, they would not be allowed to deduct (otherwise) allowable expenses in calculating the tax payable on their trading income, or to claim any other allowances. Effectively, they would be taxed on business income, rather than profit. The trading allowance is described in more detail here.
In addition to paying income tax on business profits, sole traders will also have to pay income tax on income from other sources, such as:
- money earned, and benefits received, from employment;
- pensions;
- rental income;
- benefits from the state; and
- savings interest and other investment income.
CGT
Sole traders may also have to pay CGT, if they dispose of business (or personal) assets. Taxable gains are calculated in the manner described in the Different Types of Tax section.
NICs
Sole traders may also need to pay Class 2 and Class 4 NICs depending on their profits (see the section entitled Different Types of Tax ).