How to set aside cash for your tax bill

Tax is owed on profit, not on what you drew. The gap between those two is where January surprises come from.

For sole traders and partners, tax is calculated on business profit whether or not you took the money out. Reinvest everything and you still owe tax on it.

Step-by-step

1. Enter your expected profit.
2. Enter your tax rates and allowances.
3. Read what to reserve, and by when.

Set aside as you earn

Reserve a percentage of every payment received rather than facing the whole amount at the deadline. A separate savings account and a standing habit turns a large annual shock into something already handled.

Err high. Over-reserving means a pleasant surplus; under-reserving means borrowing at the worst moment.

Payments on account

The one that catches people in their second year. Many systems require advance payments toward next year's bill alongside this year's — so the first bill after a good year can be one and a half times the tax actually owed for it.

A first profitable year is therefore followed by a bill much larger than the profit implies. Knowing this in advance is the difference between planning and panic.

A rising income makes it worse

Progressive rates mean a better year is taxed at a higher average rate. Reserving last year's percentage against a much larger profit leaves you short, so recalculate the rate rather than reusing it.

Frequently asked questions

Do I owe tax on money I left in the business?

As a sole trader or partner, yes — tax is on profit, not on drawings. Reinvesting does not defer it.

What are payments on account?

Advance instalments toward next year's tax, required in many systems alongside the current bill. They make the first bill after a good year substantially larger than the tax owed on that year alone.

What percentage should I set aside?

It depends on your rates and allowances, and rises as profit rises. Recalculate each year rather than reusing last year's percentage, and round upward.