If you are a new sole trader aiming to run a full-time business, or just have a hobby business on the side, you may be wondering about tax. The good news is that there is a type of tax relief available. Known as the trading allowance, it has an impact on the amount of tax that you have to pay,
What is the trading allowance?
The trading allowance was first put into place in 2017 to give extra tax relief to sole traders and those with hobby side businesses. If you’re a sole trader whose business income is less than £1,000 a year, you don’t have to register for Self Assessment or pay tax on this income.
You will have to register with HMRC if your self-employed incomes goes over the £1,000 threshold in a tax year.
Can I claim the trading allowance on my tax return?
The trading allowance can also be offset against your business profits. This means that you can deduct £1,000 from your profit figure, which reduces your tax bill.
If you do claim for the trading allowance, you won’t also be able to claim for expenses on your tax return. You can use either, but not both at the same time, so work out which helps you most.
For instance, if your expenses total £1,200 worth of expenses, claiming these gives you a bigger reduction. If your expenses for the year are £750, claiming the trading allowance on your return will be more useful.
The difference between profit and income
Whilst some use the terms profit and income interchangeably, they mean very different things.
Income is also known as gross revenue – it’s the money you receive as a business during a given period.
Profit is the amount you have left over after deducting expenses. This is the amount you really make.
Is the trading allowance based on profit or income?
The trading allowance applies to your gross income, before deducting tax and expenses. For example; you have business income of £1,500 in a tax year. You’ll need to register with HMRC and submit a Self Assessment tax return, even if you have £700 of expenses which bring your profit to £800.
Is the trading allowance more tax efficient than claiming expenses?
If you have expenses which add up to more than the £1,000 trading allowance, then it’s more efficient to claim for those.
If your total expenses are less than the £1,000 trading allowance, then it’s more tax efficient to claim your trading allowance instead of your expenses.
Registering for Self Assessment
If it looks like you’ll be earning more than £1,000 a year, you’ll need to register as self employed with HMRC. When you register, you’ll need to file a Self Assessment tax return each year.