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 trading allowance might have 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. The aim was to give extra tax relief to sole traders and those with side businesses.
If you’re a sole trader with business income of less than £1,000 a year, you don’t have to register for Self Assessment or pay tax on this income. If your income goes above the £1,000 threshold, you’ll need to register with HMRC and submit Self Assessment tax returns.
The trading allowance can also be offset against your business profits. The £1,000 threshold is deducted from your profit figure and reduces your tax bill, though, if you claim for the trading allowance, you won’t be able to claim for expenses as well. If you have £1,200 worth of expenses, it makes more sense to claim those against your tax bill, rather than using the trading allowance.
The difference between profit and income
While the terms profit and income are sometimes used 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 expenses have been deducted. 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 tax and expenses are deducted.
For example, if you have business income of £1,500 in a tax year, then you will 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.