Whether you work for an employer or for yourself as a sole trader, taxes are unfortunately a fact of life.
As much as we would all like to find ways to avoid it entirely, we’re sorry to confirm that if you’re earning an income, you’re obliged to pay income tax. Ouch.
To make matters more complicated, figuring out how much you owe HMRC can involve a fair bit of maths. That’s because HMRC operates using a progressive income tax rate system with multiple tax brackets. Instead of handing over a set percentage of your taxable income every year, your personal tax rate will fluctuate depending on how much you earn.
There are also a few different things that can affect how much tax you ultimately pay. If you earn under £100,000 for example, you may be eligible for the full Personal Allowance of £12,570 tax free. The first £1,000 you earn as a sole trader is also tax free – this is considered your “trading allowance”. Finally, sole traders are also allowed to claim business expenses against their taxable income for further tax relief.
We realise we’ve just said the word “tax” a lot – but what does all this mean, exactly? Better yet, how can you make the most of this system to (legally) pay less in taxes? Don’t worry, we can help. In this article, we’ll explain:
- What tax rates are
- What tax brackets are
- Individual tax rates 2024/25
- How tax brackets and tax rates work together
- How claiming business expenses affects your effective tax rate
- Ditch the maths and use Hnry
Let’s get stuck in!
Note: this article only covers income tax rates, excluding the National Insurance and student loan repayments which may also impact how much you’ll need to set aside for the end of the financial year (EOFY).
What is a tax rate?
We’re so glad you asked!
A tax rate is defined as the ratio between a sum of money and the tax owed on that money, calculated as a percentage. Don’t worry; it’s not as confusing as it sounds.
For example, if you had £100 of taxable income, and paid £10 of that in tax, the ratio between income and tax would be 10:100, simplified to 1:10. This ratio in percentage form is 10% – your tax rate.
If you wanted to simplify that even further, you could take the maths out of it and think about it like this: A tax rate is the percentage at which a person or business is taxed.
Some tax rates are easy to calculate – for example, VAT (Value-Added Tax). It’s set at a flat rate of 20% on top of the cost of most goods and services. Fairly straightforward.
Other tax rates change depending on the circumstances. For example, income is taxed progressively, meaning that the tax rate is different for different tax brackets.
Which leads us nicely to our next section:
What’s a tax bracket?
Income tax is a progressive tax, meaning that the more you make, the higher your overall tax-to-income ratio.
To this end, income levels are split into bands, each taxed at a different rate. Income tax bands are the same for everyone, whether you’re an employee or a sole trader.
Tax bands and their corresponding tax rates are decided on by the government – they’re not set in stone. Different political parties have different views on what fair taxation looks like, and economic factors (like inflation) can change the value of money to the point where the system isn’t working as designed.
Previously, the government regularly increased tax thresholds in line with the Consumer Price Index (CPI) – basically, the inflation rate. But as of 2022, confirmed in the 2024 budget, all personal tax thresholds have been frozen until April 2028.
Income Tax rates and bands (FY 2024/25)
England, Northern Ireland, and Wales
| Band | Taxable income | Tax rate |
|---|---|---|
| Personal Allowance | £0 - £12,570 | 0% |
| Basic rate | £12,571 - £50,270 | 20% |
| Higher rate | £50,271 - £125,140 | 40% |
| Additional rate | £125,141+ | 45% |
Source: gov.uk
Scotland
| Band | Taxable income | Tax rate |
|---|---|---|
| Personal Allowance | £0 - £12,570 | 0% |
| Starter rate | £12,571 - £14,876 | 19% |
| Basic rate | £14,877 - £26,561 | 20% |
| Intermediate rate | £26,562 - £43,662 | 21% |
| Higher rate | £43,663 - £75,000 | 42% |
| Advanced rate | £75,001 - £125,140 | 45% |
| Top rate | £125,141+ | 48% |
Source: gov.uk
How tax brackets and tax rates work
Income tax is calculated based on all your taxable income, whether you earn your income from a salary, a business, a side hustle, or any combination of all the above.
With that in mind, here’s where it gets more complicated: not every pound you earn will be taxed at the same rate. That’s where tax bands come into play.
It’s a common misconception that your entire salary is taxed at the rate of the top tax band you qualify for, but this actually isn’t true. For example, if you’re based in England, earn £30,000 a year, and fall into the basic rate band, you may think you need to set aside 20% of your income for tax, eg. £6,000.
But our progressive tax rate system means that you actually pay no tax on your Personal Allowance (the first £12,570 you earn), and 20% on earnings in the basic rate band, which in this case would be the remainder of your income:
Personal Allowance: 0% of £12,570 = £0
Basic rate: 20% of £17,430 = £3,486
Total income tax bill: £3,486
This makes your effective income tax rate 11.62% - far less than paying 20% across the board!
📄 An effective tax rate is exactly what it says on the tin: the actual percentage of your total income that you pay in income tax.
Your effective tax rate is unique to your situation, and is a better metric for tracking your taxation levels than the different bands. It may vary wildly depending on where your income falls within the bands, as well as what allowances you qualify for – the closer you are to the top end of the bracket threshold, the higher your effective tax rate will be.
For example:
Sam and Ella are both freelance designers living and working in Birmingham. Sam only recently started designing full time, and has a yearly income of £27,000. In contrast, this isn’t Ella’s first rodeo; she’s been at this a while, and will make around £50,000.
Even though both their annual incomes fall within the basic rate band (20%), Sam’s effective tax rate is 10.6%, while Ella’s is 14.9%. This is because only £14,430 of Sam’s income is taxed at 20%, in contrast to £37,430 of Ella’s income.
At the end of the financial year, Sam’s income tax bill is £2,886. Ella’s income tax bill is nearly double that, at £7,484. Sam commiserates with Ella by taking her out for a beer. He picks up the bill.
But wait! There’s actually some good news here, especially if you’re a sole trader. You can reduce your taxable income – and therefore your effective tax rate – by claiming tax deductions for approved business expenses (🎉).
How claiming business expenses affects your tax rate
To help sole traders and small businesses keep more of their money, HMRC allows some business expenses to be claimed as tax deductions. What this essentially means is that you can spend money on growing your business, and you don’t have to pay as much income tax come the EOFY. Win win!
Here’s how it works:
- You purchase a good or a service that directly relates to earning your sole-trader income
- You claim the cost of the expense as a tax deduction
- The cost of the expense is excluded from your taxable income, which reduces the income you pay tax on and lowers your effective tax rate
- You pay less in taxes at the end of the financial year.
Source: HMRC
💡 Note: this doesn’t take into account any National Insurance payments or student loan repayments you may owe, or the trading allowance. For more information, check out our Tax 101 article.
This is oversimplifying it – HMRC won’t accept purchases made willy-nilly – but if you’re clever about it and the stars align, you could make a real difference to your final income tax bill.
💡 If you’re not sure whether an expense will be accepted as a tax deduction by HMRC, it’s always a good idea to check with a tax specialist (like the Hnry team!)
How Hnry Helps
Hnry is an award winning app and tax service, designed specifically for sole traders. For just 1% + VAT of your self-employed income, capped at £650 a year, Hnry will calculate and pay all your taxes and whatnot for you, including:
- Income tax
- VAT
- National Insurance
- Student loan repayments
- Private pension contributions (optional)
Our app models your income throughout the year and predicts your effective tax rate based on what you earn. We only ever deduct what we estimate you’ll owe, meaning you won’t get behind (or ahead!) on tax payments. You also won’t have to set money aside yourself – in fact, you’ll barely have to think about taxes at all.
Better still, using the Hnry platform costs less than using a traditional accountant, and is entirely tax deductible.
If that sounds good to you, join Hnry today and never think about tax again!
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