Taking the leap from employment to self-employment is an exciting venture, but it also brings a new set of tax responsibilities. At Max Pro Accountants, we understand that navigating these initial stages can feel daunting. This guide outlines the key tax considerations for new business owners, ensuring you start your entrepreneurial journey on solid financial footing.
1. Stepping into Self Assessment
As an employee, your tax obligations are largely handled through PAYE (Pay As You Earn), where your employer deducts income tax and Class 1 National Insurance contributions (NICs) directly from your salary. However, as your own boss, this changes. You become responsible for accounting for both income tax and NICs yourself. The first crucial step is registering for Self Assessment. This can be done by completing a Form SA1 or registering online via the Government Gateway. Upon registration, you’ll receive a Unique Tax Reference (UTR) number, which is essential for submitting your tax returns.
2. Understanding Your National Insurance Obligations
Alongside income tax, you’ll also need to manage your National Insurance contributions. While you previously paid Class 1 NICs through PAYE, as a sole trader, you’ll primarily pay Class 4 NICs through your Self Assessment tax return. It’s also important to be aware of recent changes to Class 2 NICs. Prior to April 2024, a fixed weekly rate was payable. However, since then, Class 2 NICs have become optional for those with income below the Small Profits Threshold (£6,725 for the 2024-25 tax year), allowing individuals to maintain their entitlement to state benefits.
3. Mastering Accounts and Tax Returns
Efficient record-keeping is paramount for self-employed individuals. If your turnover is below £85,000, you can submit a simplified “three-line account” detailing your turnover, expenses, and profit. However, exceeding this threshold necessitates a more comprehensive breakdown of your expenses.
Looking ahead, Making Tax Digital (MTD) for Income Tax is set to transform how many sole traders submit their returns. From April 2026, those with a turnover above £50,000 will be required to submit quarterly digital returns, with this requirement extending to those with a turnover above £30,000 from 2027. Furthermore, the tax year basis for businesses changed in April 2024, aligning with the standard tax year rather than the previous “current year basis.” This may require businesses with non-March year-ends to apportion income and expenses across different tax years.
Finally, the default accounting method is now the cash basis, meaning you’re taxed on income when you receive it and expenses when you pay them, although you can still opt for the traditional accruals basis.
4. Navigating VAT Registration
As your business grows, you’ll need to be mindful of Value Added Tax (VAT). Once your turnover exceeds £90,000 within a 12-month period, VAT registration becomes mandatory.
However, even if your turnover is below this threshold, voluntary registration might be advantageous, particularly if your customers are VAT-registered or if you supply zero-rated goods or services. VAT returns are typically submitted quarterly, with the difference between the VAT you’ve charged on your sales (output tax) and the VAT you’ve paid on your business purchases (input tax) being payable to HMRC.
Zero-rated suppliers can often reclaim all their input tax and may benefit from monthly returns to improve cash flow. If your turnover subsequently falls below £88,000, you can apply to cancel your VAT registration.
5. Considering a Partnership Structure
If you plan to run your business with a spouse, family member, or friend, operating as a partnership could be an option. For tax purposes, a trading partnership isn’t a separate legal entity that pays tax itself. Instead, each partner is taxed on their individual share of the partnership’s profits through their personal income tax return and NICs. Despite this “transparent” tax treatment, the partnership still requires its own UTR number and files a partnership tax return detailing each partner’s profit allocation.
Partnerships also have their own VAT identity and VAT number, distinct from the individual partners. The legal framework for partnerships is primarily governed by the Partnership Act 1890, which outlines aspects like equal ownership, equal say in management, and automatic dissolution upon a partner’s death. A formal partnership agreement is crucial to tailor these default provisions to your specific needs, outlining profit sharing, responsibilities, and capital contributions.
6. Exploring the Benefits of Incorporation
As your business evolves, you might consider incorporating, which involves transferring ownership to a limited company in exchange for shares and potentially a director’s loan account. In this structure, the shareholder owns the company, and the director manages its operations (often the same person in owner-managed businesses). Incorporation creates a legal distinction between you and your business, limiting your personal liability to your investment.
The company’s profits are subject to Corporation Tax, and you’ll typically extract profits as dividends (as a shareholder) or salary and pension contributions (as a director). While these extracted profits are taxed again at your personal level, careful remuneration planning can often lead to overall tax efficiencies, particularly when profits aren’t fully extracted immediately.
7. Planning for the Future: Selling Your Business
Eventually, you might decide to sell your business. The tax implications of this will depend on your business structure. As a sole trader, you’ll be selling your business assets, including goodwill and client lists, which will be subject to Capital Gains Tax (CGT). Business Asset Disposal Relief (BADR) may be available, potentially reducing the tax rate on up to £1 million of lifetime gains from the sale of qualifying business assets.
Partners selling their share in a partnership are also subject to CGT, with BADR potentially applicable. If your business is incorporated, you’re selling shares in the company, rather than the assets directly. CGT applies to the sale of these shares, and BADR may again be available if you’ve also been a director or officer of the company. Alternatively, the company could sell its assets, with you retaining ownership of the company as a holding entity, or the company could be formally liquidated, which is also treated as a capital disposal for tax purposes.
8. Ready to Navigate Your Business Tax Journey with Confidence?
Starting your own business is a significant step, and understanding your tax obligations from the outset is crucial for long-term success.
At Max Pro Accountants, we’re here to guide you through every stage of your entrepreneurial journey, from registering for Self Assessment to planning for potential business sale. Don’t navigate the complexities of business tax alone. Contact Us HERE today for expert advice and support tailored to your specific needs.