Sole trader - cash basis or traditional accounting for tax return?

Bricks

I'm self employed and a sole trader. My income and expenditure are quite straightforward: income is in the form of invoices for professional services, and expenditure boils down to some things like PI insurance and software licences. I work from home so am not paying office rent etc.

So far I have really just stated my income as the sum of all my invoices, and not really bothered to deduct expenses, because they have a minimal effect on the amount of tax I end up paying.

And so far I have not ticked the "cash basis" box. I think I decided not to do this, because it simplified the process of totting up income - I just include the invoice in the relevant tax year according to the invoice date rather than having to check when each one was actually paid.

But I'm now at a point where it probably makes sense to start deducting expenses in order to arrive at my real "profit". Would I be right to think that the "cash basis" approach might be the most straightforward? And if so, will I cause myself problems going from "traditional accounting" one year, to "cash basis" the next?

Grumpy_chap

You should record and deduct expenses, irrespective of whether they are nominal sums.  If the expenses keep you in basic rate tax rather than slipping up into the next band, they become more valuable.  Also, you want to demonstrate you are not simply an employee in disguise - PI cover can be an indicator in that regard.

I cannot advise about whether cash accounting would be simpler for you and / or a better option.

Do you have an Accountant?  If not, get one.  As well as whether to go to cash accounting, an Accountant can also advise whether sole trader or Ltd Co is preferable and also about VAT registration (or not).

Bricks

I don't have an accountant because my accounts have been very straightforward so far. And the amounts of money involved have been relatively small. It's unlikely that an accountant's fees would be less than the money they would save. That may change in the future but I'm not at that point quite yet.

Jeremy535897

If your expenses are straightforward, I doubt the cash basis will save you any time. For the accruals basis, which is what you are using, you go by the invoice date for expenses as well as income, although for things like insurance you should look at the period of cover and apportion it to your accounts periods accordingly (if your accounts are to 31 March 2021 and your insurance runs from 1 October, you include half the insurance for the year to 30 September 2020 and half for the year to 30 September 2021). It would normally be acceptable from a practical point of view just to include the figure for the year to 30 September 2020.

If your expenses are small, under £1,000, you should claim the trading allowance instead of actual expenses.

I don't like the cash basis, mainly because you cant set any losses against other income, and you have much less flexibility on claiming relief for plant and machinery. It also gives you a set of accounts that are not very useful from an information point of view. There are also complicated transition rules if you move from one basis to another.

oldbikebloke

although the tax return requires you to positively confirm use of cash basis, in reality HMRC would be surprised that a sole trader is not using the cash basis (if they qualify to do so: turnover <£150,000 and not in one of the exceptional trades activity) since the whole point of it is its simplicity

whilst you are of course entitled to chose to pay extra tax by not claiming costs, the fact you have not claimed them on last year's return will make the transition to cash basis slightly simpler.
In your case, you therefore need only focus on making sure you are not double counting any income received during 19/20 previously declared as income in 18/19's invoice date total. Obviously invoices not paid at 5 April 20 won't now be included in 19/20 tax return 

if you really want to keep things very simple, then why not claim the trading allowance instead of your actual costs?
Are you aware of the trading allowance? Tax-free allowances on property and trading income - GOV.UK (www.gov.uk)
If your expenses are <£1,000 then it would be madness not to claim the allowance instead of actuals 
if your actuals are >£1,000 then be careful when claiming use of home costs and consider using the simplified expenses approach instead for them Simplified expenses if you're self-employed - GOV.UK (www.gov.uk)

Bricks

Jeremy535897 said:

If your expenses are straightforward, I doubt the cash basis will save you any time. For the accruals basis, which is what you are using, you go by the invoice date for expenses as well as income, although for things like insurance you should look at the period of cover and apportion it to your accounts periods accordingly (if your accounts are to 31 March 2021 and your insurance runs from 1 October, you include half the insurance for the year to 30 September 2020 and half for the year to 30 September 2021). It would normally be acceptable from a practical point of view just to include the figure for the year to 30 September 2020.

If your expenses are small, under £1,000, you should claim the trading allowance instead of actual expenses.

I don't like the cash basis, mainly because you cant set any losses against other income, and you have much less flexibility on claiming relief for plant and machinery. It also gives you a set of accounts that are not very useful from an information point of view. There are also complicated transition rules if you move from one basis to another.

Thanks.

My expenses are maybe slightly more than £1000, but I may look at just claiming the trading allowance rather than spending the time to work it all out accurately, only in order to save a small amount of tax.

My "accounts" at present are not really much more than a spreadsheet where each invoice is listed against a date and project, and then they are added up to give a total for the year. Should I be starting do do something more formal than that?

Jeremy535897

Bricks said:

Jeremy535897 said:

If your expenses are straightforward, I doubt the cash basis will save you any time. For the accruals basis, which is what you are using, you go by the invoice date for expenses as well as income, although for things like insurance you should look at the period of cover and apportion it to your accounts periods accordingly (if your accounts are to 31 March 2021 and your insurance runs from 1 October, you include half the insurance for the year to 30 September 2020 and half for the year to 30 September 2021). It would normally be acceptable from a practical point of view just to include the figure for the year to 30 September 2020.

If your expenses are small, under £1,000, you should claim the trading allowance instead of actual expenses.

I don't like the cash basis, mainly because you cant set any losses against other income, and you have much less flexibility on claiming relief for plant and machinery. It also gives you a set of accounts that are not very useful from an information point of view. There are also complicated transition rules if you move from one basis to another.

Thanks.

My expenses are maybe slightly more than £1000, but I may look at just claiming the trading allowance rather than spending the time to work it all out accurately, only in order to save a small amount of tax.

My "accounts" at present are not really much more than a spreadsheet where each invoice is listed against a date and project, and then they are added up to give a total for the year. Should I be starting do do something more formal than that?

Presumably you are not registered for VAT? I suspect there will be a requirement to use MTD compliant accounts software when self assessment goes into MTD (April 2023 target date), if business income exceeds £10,000.

Bricks

No, I'm not VAT registered.

Bricks

if you really want to keep things very simple, then why not claim the trading allowance instead of your actual costs?
Are you aware of the trading allowance? Tax-free allowances on property and trading income - GOV.UK (www.gov.uk)
If your expenses are <£1,000 then it would be madness not to claim the allowance instead of actuals 
if your actuals are >£1,000 then be careful when claiming use of home costs and consider using the simplified expenses approach instead for them Simplified expenses if you're self-employed - GOV.UK (www.gov.uk)

I wasn't aware of this so thanks for pointing it out. As it turns out, my expenses this year came to less than £1000 so I'm going to use this method instead.

I just put £1000 in the "trading income allowance" box, and my full takings in the turnover box, and it subtracts for me later in the calculations, is that right?

Jeremy535897

Bricks said:

if you really want to keep things very simple, then why not claim the trading allowance instead of your actual costs?
Are you aware of the trading allowance? Tax-free allowances on property and trading income - GOV.UK (www.gov.uk)
If your expenses are <£1,000 then it would be madness not to claim the allowance instead of actuals 
if your actuals are >£1,000 then be careful when claiming use of home costs and consider using the simplified expenses approach instead for them Simplified expenses if you're self-employed - GOV.UK (www.gov.uk)

I wasn't aware of this so thanks for pointing it out. As it turns out, my expenses this year came to less than £1000 so I'm going to use this method instead.

I just put £1000 in the "trading income allowance" box, and my full takings in the turnover box, and it subtracts for me later in the calculations, is that right?

Should be. Check it to ensure you've done it right.