The £1,000 tax-free trading allowance was introduced in 2017 for self-employed, casual workers and those with a hobby business. It provides tax relief to save you money but how does it work?
The concept of the £1,000 tax-free trading allowance is pretty simple: it gives individuals with trading income of £1,000 or less a tax exemption. For those whose trading income is over £1,000, you have the option to use the allowance instead of deducting your expenses which could lower your tax bill.
We discuss both situations below along with the limitations of the £1,000 tax-free trading income allowance and what processes must be completed in relation to HMRC.
What is trading income?
Trading income is any income that comes from self-employment, casual services or selling of goods. If you’re employed, the £1,000 exemption is on top of your regular income and isn’t affected by how much you earn in your day job.
Here are some examples of trading income:
Money earned through self-employment
Casual services such as babysitting, dog walking or gardening
Loaning out of equipment such as power tools for a fee
Trading of goods on Ebay
What if I earn less than £1,000 from trading income?
If you earn £1,000 or less from trading income in a single tax year (April to March) then this is completely tax-free. What’s more, you do not need to inform HMRC and you are not required to fill in a self-assessment tax return.
Of course, you may be required to fill in a self-assessment for other income – check out our self-assessment guide for more information.
There may also be reasons for volunteering to fill in a self-assessment tax return – for example voluntarily paying Class 2 National Insurance.
Example:
Luna does some freelance writing work in addition to her full-time job. She earns £650 a year from this and all her other income is from her employment. As Luna’s trading income is below £1,000 she does not need to register with HMRC, fill in a self-assessment tax return or pay tax on this income.
What if I earn more than £1,000 from trading income?
If your trading income is over £1,000, you must register with HMRC and fill in an annual tax return – check out our guide on how and when to set up as a sole trader for more information.
However, you may still be able to take advantage of the trading income allowance. Instead of deducting your allowable expenses from your profit for your self-assessment tax return, you may instead deduct the trading income allowance.
You can deduct up the £1,000 limit but no more. In addition, you cannot deduct more than your trading income and result in a loss.
Examples:
Ron set up a dog walking business and earnt £1,800 within the tax year. He has very few expenses and they total £400. If Ron deducts his expenses from his training income his profit would be £1,200 and he would need to pay the tax liable for this figure.
However, if Ron uses the trading allowance then deducting this from his income would result in profit of £800 and this is the figure, he would need to pay tax on. Therefore, using the trading income allowance would result in lower profit and save tax.
Oliver has started a sports coaching business and in the first year, his trading income is £1,500. If he uses the trading allowance this would result in a profit of £500. However, as he had to buy quite a bit of equipment for his startup his expenses are £1,200.
Using his expenses results in a £300 profit, so in this case using Oliver’s actual expenses would make his profit lower and save tax.
Summary
It’s always prudent to consider the £1,000 tax-free trading income allowance, especially if you’ve just started a small business or income in addition to your regular job tips over the £1,000 mark.
Even if you don’t hit that threshold with your trading income, remember that you must still retain all financial records.
At Lava Sky Accounting we offer affordable start-up packages that scale up as your business grows, helping you get your dream business off the ground. Get in touch to book a free consultation and find out more.