Unless you’re a trained accountant, understanding how taxes work can be a real headache. Still, it’s crucial to know how much you owe in tax to avoid paying too much or too little.
It’s also important to be aware of when you need to start paying taxes, in other words, how much money you can make tax-free: your personal allowance.
To help you understand personal allowances, this guide will answer:
- What is a personal allowance?
- How much can I earn tax-free?
- How do I report my income as self-employed?
- What are other allowances I should know about?
What is a personal allowance?
In the UK tax system, your personal allowance is the threshold above which you need to start paying Income Tax. As soon as you exceed the personal allowance amount, your income is taxable according to specific tax brackets, which we’ll explain below.
The standard personal allowance for the 2021/2022 tax year is £12,570. However, your tax-free threshold may be higher if you claim marriage allowance or a blind person’s allowance.
Additionally, if you’re eligible for a trading allowance, the rules are different, as we’ll explain later in this article.
How much can I earn tax-free as self-employed?
Most people may receive a set amount of income before needing to pay income tax, known as the basic personal allowance. The basic personal allowance (£12,570 for 2021/22) is the same for everyone who earns less than £100,000 in annual income, above which the allowance is reduced.
How much you pay in tax also depends on where in the UK you live.
England, Wales and Northern Ireland
If you live in these regions and earn between £12,570 and £50,270 annual income, you pay the basic income tax rate at 20%.
People who make between £50,270 and £150,000 fall within the higher-rate tax threshold, meaning they pay 40% income tax.
Those that make over £150,000 pay the additional rate at 45%.
In Scotland, people who earn between £12,570 and £14,667 pay a starter rate of 19% income tax.
Those who make between £14,667 and £25,296 will pay the basic rate of 20%.
If you earn between £25,296 and £43,662, you’ll be charged the intermediate rate of 21%.
Individuals making between £43,662 and £150,000 pay the higher rate tax of 41%.
Finally, earnings above £150,000 have to pay the top rate of 46% income tax.
The government has a tax calculator that estimates how much you need to pay in tax, so you don’t have to calculate it yourself.
Find out more about income tax brackets here.
Income above £100,000
For those that make more than £100,000 in annual income, the basic personal allowance gets reduced £1 for each £2 you earn above the £100,000 limit. It doesn’t matter how old you are.
This means that if your income is above £125,000, you receive no personal allowance, and all your income gets taxed.
Sole traders’ personal allowance
Sole traders have the same personal allowance as employees (£12,570), meaning that you won’t pay income tax if you earn less.
If you make between £12,571 and £50,270, you pay the basic rate of 20%.
However, after that, you’re taxed slightly differently. If your earnings fall between £50,271 and £150,000, you pay the higher rate of 40%.
Sole traders making more than £150,000 pay the additional rate of 45%.
In Scotland, sole traders are taxed at the same rates as other employees.
As a sole trader, you’ll need to send a Self Assessment tax return every year to HMRC and pay National Insurance. If your company makes more than £85,000 over 12 months, you must also register for VAT.
Sole traders do not need to pay corporation tax.
How do I report my income as self-employed?
As a sole trader or small business owner, you need to report your taxable income to HMRC in your annual self-assessment tax return, which you fill in after the end of the tax year (5 April) it applies to.
Keep records of bank statements and receipts to help you fill in your tax return correctly. You can find out more about how to fill out your self-assessment tax return in these government helpsheets.
Once you register as self-employed with HMRC, you’ll receive a notice shortly after the end of the tax year reminding you to complete a tax return for that tax year.
However, if you’re eligible for a trading allowance, you do not need to report this income to HMRC.
What other allowances should I know about?
Below we’ve listed some of the other allowances you might be able to claim.
Marriage allowance lets you transfer £1,260 of your personal allowance to your spouse or civil partner. You may end up paying more yourself, but you could pay less as a couple.
The lowest earner must normally have an income below the personal allowance (£12,570).
You can calculate how much tax you could save as a couple using this tool.
If you’re a sole trader with a business income under £1,000 a year, you don’t have to pay tax on your income or register for self-assessment with HMRC. This applies to people with income coming from:
- Casual services like babysitting or gardening
- Hiring out personal equipment like power tools
The first £2,000 you receive in dividends from investments is tax-free, after which you pay taxes at the following rates:
- Basic-rate taxpayers pay 7.5%
- Higher-rate taxpayers pay 32.5%
- Additional-rate taxpayers pay 38.1%.
The government website has more information about blind person’s allowance, marriage allowance, and trading allowance so you can learn more about them. We also have a separate guide that gives you more information about dividends.
Blind person’s allowance
If you’re eligible for a blind person’s allowance, you get an extra £2,520 added to your annual personal allowance. If both you and your spouse or civil partner qualify, you’ll both receive the allowance.
You can also transfer your Blind Person’s Allowance to your spouse or civil partner if you don’t pay tax or earn enough to use the whole allowance.
Countingup makes tax planning easier
Take the stress out of bookkeeping and tax planning with Countingup’s 2-in-1 business current account and accounting software.
With the simple app, you’ll receive real-time profit and loss reports, tax estimates, cash flow, and instant invoices to help you stay on top of your business operations. Find out more here.