What taxes does a self-employed person pay?

Running your own business provides flexibility and control over how and when you work. But it comes with the need to manage your own taxes, so what taxes does a self-employed person pay?

We’ll walk you through how and why tax filings differ for self-employed business owners and what you need to know to maximise your income and stay tax compliant. Discover:

• Why taxes for sole traders and company directors differ
• Three taxes you may pay as an entrepreneur
• How to do a Self Assessment Tax Return before the deadline
• How to simplify your taxes

There are many similarities in rates that sole traders and limited company directors have to pay for things like income tax and national insurance. However, there are differences that arise from how their respective taxes are filed and what they each pay tax on.

Even though both sole traders and limited company directors run businesses, they are treated differently. This is because sole traders are considered closer to the business they run and, in many senses, are considered one and the same. For this reason, they pay income tax (and other taxes) directly from their business’ profits. 

However, directors and the limited companies they run are considered legally separated from one another. Therefore, directors are considered employees of the company. For this reason, directors also pay income tax though this is typically filed through HMRC’s PAYE (pay as you earn) system instead of the Self Assessment that sole traders need to complete. In addition to this, there are other ways in which company directors can be paid and pay tax, which we will discuss later. 

Despite this difference in employment status, company directors are often considered self-employed even if, legally speaking, this is incorrect. Finally, unlike sole traders, limited companies are subject to different tax arrangements, namely having to pay Corporation Tax. Note that this also does not affect the personal income of directors.

To understand more about the different tax rates that businesses pay, read our article What taxes do businesses & sole traders pay?

Starting out, while both sole traders and limited company directors pay National Insurance, each pay different ‘classes’.

If you have a limited company and are paid through the payroll (via PAYE), you’ll need to deduct Class 1 employee’s National Insurance from your wages and pay that to HMRC. Your company will also need to pay Class 1 employer’s National Insurance for any amount over the employment

In contrast, sole traders don’t pay Class 1. Instead, they pay two kinds of National Insurance.

Sole traders who earn more than £6,515 annually must pay Class 2 National Insurance, working out to be around £3 a week. 

Fortunately, if you earn less than this threshold, you can voluntarily pay Class 2 National Insurance to protect your entitlement to State Pension and other benefits in the future.

As your profits increase, sole traders who earn between £9,569 and £50,270 also need to pay Class 4 National Insurance at a rate of 9%. 

If you earn beyond this upper threshold, you’re charged an additional 2%. .

Income tax is relative to your income you receive as an individual. For sole traders, this will be based on the profits your business generates whereas, for company directors, this will be based on the salary you pay yourself through the company. 

Income tax is applied to earnings above the tax-free allowance of £12,570. Note that additional earnings like savings interest or capital gains will also account for your income and could push you into a higher tax bracket. 

• Basic rate – 20% on earnings above £12,571 but below £50,270
• Higher rate – 40% on earnings above £50,271 but below £150,000
• Additional rate – 45% on earnings above £150,000

The Personal Allowance amount goes down by £1 for every £2 of income above the £100,000 and can go down to zero – meaning you’ll have your entire income taxed. Learn more about how much income tax you’ll need to pay here, including the rates unique to Scotland here.

Dividends are a form of income that companies pay to shareholders from its profits. Therefore, only company directors pay this type of tax. 

Similar to the personal allowance for income tax, you can earn some dividend income every year without paying tax. Currently, this is placed at £2,000. Above this limit, the tax rate will depend on your tax bracket (see above) and should be declared through Self Assessment. 

You can maximise your income as a company director by combining these allowances: theoretically, you could earn up to £14,500 in dividends before you need to pay tax (£12,500 personal allowance + £2,000 dividend allowance).

You can complete and file your Self Assessment tax return online. 

Sole traders must file their income each year after the end of the tax year but before the January 31st deadline. 

Limited company directors don’t have to file a Self Assessment as long as their entire income has come through PAYE. If you receive dividends or company benefits however (like use of a company car), you’ll need to pay income tax and national insurance where relevant. This is also done via Self Assessment and must be completed  before the same deadline as above.

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