Sole traders and individuals in the UK can also save tax by having a good tax plan.
In this blog, I have explained how this can be achieved.
Main Tax Paid by Sole traders
A sole trader usually pays mainly three types of tax.
Income tax for Sole traders
A sole trader would pay income tax if the profit received from their business exceeds the personal allowance threshold which for the tax year 2018/19 is £11,850.
If the profit is between £11,851 and £46,350, they will pay tax at the introductory tax rate of 20%.
This increases to 40% or 45% if the profit is more than this.
Profit over 100,000 will see a restriction to the personal allowance. This means, that for every £2 your profit is over £100,000, and your personal allowance is reduced by £1.
Consequently, your personal allowance will be zero if the profit is £123,700 or above.
The due date for tax owed from the previous year is usually paid by the 31st of January.
When the tax owed is more than £1000, the taxpayer would have to make payment on account of the tax expected to be paid in the next tax year.
To know more about ways of paying tax kindly click.
Class 2 national insurance for Sole traders.
This is charged at £2.95 for every self-employed person in the UK
A sole trader with a profit of less than £6,205 will be exempted from class 2 national insurance.
Class 4 national insurance for Sole traders.
This paid at 9% on every profit over the limit of £8,424.
How Sole traders and individuals can reduce tax.
As tax is paid on profit, here are examples of transactions that a sole trader can make that can reduce his tax in a tax year.
1. Contribution to a Personal pension scheme by Sole traders.
The sole trader would enjoy relief at the source of the contribution.
The advantage of doing so is that the amount paid into the pension scheme is grossed up by 20% and the amount derived is used to extend the basic band and also the higher and additional rate for high earners.
Let’s say Mr A pays £5000 into a registered personal pension in June 2017.
The 5000 would be multiplied by 100/80=6250.
The 6250 would be added to his basic band at 33000; therefore Mr A will still be able to pay tax at 20% on the 6250 rather than 40% thereby saving £1250 in cash.
If he was a higher rate earner, that tax band will be extended as well.
There are limits to the amount a taxpayer can enjoy relief from the pension.
- It is the maximum of £3600 or 100% of relevant earnings.
- Also, he cannot exceed his annual allowance of £40000 for this tax year 2018/19 unless he has used the allowance from 3 previous years.
- There is also a lifetime allowance for this tax year 2018/19 which is £1 million.
2. When Sole traders gifts to Charity.
When a sole trader or individual gives to charity and the charity receives gift aid on the donations.
They can also have the advantage of the extended tax band as explained above thereby paying less tax or receiving a tax refund.
3. Sole traders Investing in plant and machinery and fixtures.
When a sole trader invests in plant and machinery or fixtures, they can claim capital allowance (except if exempted from plant and machinery especially when they fall under buildings).
For some capital investments, a sole trader could claim up to £200,000 per tax year if it qualifies for an annual investment allowance or the whole amount if it qualifies for a first-year allowance.
All this amount spent would be used to reduce the tax for the period.
Tax advice here is that sole traders should be strategic with their timing when investing in plants and machinery.
4. Marriage Allowance for Sole traders and individuals
When sole traders partners with husbands, wife or civil partners who do not use up their personal allowance can have the personal allowance of their partners transferred to them.
They can transfer £1190 of their personal allowance to them.
The benefit of this is that it reduces the sole trader’s income tax by £238(For the tax year 2018/19).
The condition to enjoy this benefit is that both couples have to pay tax at the basic band and the partner transferring must have an income lower than their personal allowance(11850)
5. Sole traders incorporating their business
Depending on the amount of profit involved it might be cheaper for the taxpayer if there is no commercial reason to incorporate the business. This would save tax by planning some of the income as salary and dividends.
If you would like to read more on the benefits and impact of incorporating your business, Kindly click