Every January, thousands of self-employed individuals and business owners face the same sinking feeling after seeing their tax bill. Many treat tax as an afterthought, and when the deadline finally arrives, the funds needed to settle the bill have long disappeared into everyday business and living costs.

The key is to start thinking of tax as a routine business expense, not an annual surprise.

This guide will help you understand:

• Why Setting Money Aside for Tax Matters
• How Much Should You Set Aside for Tax if You Are Self Employed or a Sole Trader?
• How Much Should Limited Companies Set Aside for Tax?
• Do You Need to Set Aside Money for VAT?
• What Taxes Should Small Business Owners Plan For?
• How Many Tax Savings Accounts Do You Need?
• Simple Method to Calculate How Much to Save for Tax
• Common Tax Mistakes To Avoid When Saving for Tax
• How an Accountant Can Help You Plan Ahead

Why Setting Money Aside for Tax Matters

Unlike employees who are taxed at source (PAYE), if you run a business or work for yourself, there is no employer deducting your Income Tax or National Insurance before the money hits your account. The responsibility of managing these taxes falls entirely on you.

This is why we recommend setting aside a percentage of your profit into a separate tax savings account. By doing this you can easily avoid the shock of an unexpected bill.   

This habit prepares you for the 31^st January deadline as well as the second payment on account due by 31 July. Planning ahead also helps you keep your personal and business money separate, ensuring that your tax money doesn’t quietly vanish into your daily spending.

Treating tax like a monthly expense removes the stress before it even builds up

How Much Should You Set Aside for Tax if You Are Self Employed?

The general rule of thumb for the self-employed and sole traders is to save 20% to 30% of your taxable profit. This percentage covers both your Income Tax and National Insurance contributions. If your profits push you into a higher or additional-rate tax band, you should opt towards saving 40% to 50% on the portion of profit that falls in those bands.

It is vital to understand that you only need to save from your net profit, not your total turnover. Your net profit is what remains after deducting your Allowable Business Expenses and costs from your turnover.

Understanding Payments on Account

If your tax liability exceeds £1,000, HMRC requires you to make two advance payment toward your next bill. This is known as payment on account. Instead of paying for one annual tax bill, instead you pay for two tax years at once. 

Here is how it works:

• The first payment on account is due by 31st  January alongside any balancing payment for the previous year.
• The second payment on account is due by 31st July.

If you are filing tax for the first time, this can mean paying 150% of your tax bill in January; 100% for the year just ended, plus 50% in advance for the current year.

Once you are past the first year, the system automatically balances out as you are always paying roughly half in advance every six months, rather than scrambling for one large annual payment.

How Much Should Limited Companies Set Aside for Tax?

As a director of a limited company, you are responsible for paying Corporation Tax on your company’s profit. It is recommended to set aside 20% to 25% of your profits in a separate business savings account, which is separate from your main business account.

The rate of your Corporation Tax depends on your company’s level of profit:

Profit Level	Corporation Tax Rate
£50,000 or less	19%
Between £50,001 and £250,000	19% to 25% (with Marginal Relief)
Above £250,000	25%

If your profits fall between £50,000 and £250,000, you can claim Marginal relief, which gives you a tapered rate between 19% and 25%. Setting aside 25% ensures you are fully covered for Corporation Tax.

Director Dividends and Personal Tax

Your tax planning does not stop at the company level. As a director If you take a salary above your Personal Allowance, pay yourself dividends or receive any other income from your company, you will have a personal Self-Assessment tax liability as well.

Dividends are taxed differently from salary. The rates for the current year are:

Dividend Tax Band	Rate
Dividend allowance (tax-free)	0% on first £500
Basic rate taxpayers	8.75%
Higher rate taxpayers	33.75%
Additional rate taxpayers	39.35%

A simple approach is to save a percentage of the dividends you take, based on your Income tax band.

• Basic rate taxpayer: Set aside 10% to 15% of your dividend income.
• Higher rate taxpayer: Set aside 30% to 35% of your dividend income.
•  Additional rate taxpayer: Set aside 35% to 40% of your dividend income.

It is highly recommended that you transfer a portion of every dividend payment into a separate personal tax savings account, just as you would with your business tax account.

Do You Need to Set Aside Money for VAT?

If your limited company’s taxable turnover exceeds the £90,000 threshold, you must register for Value-Added Tax (VAT), which is completely different from your business profit taxes.

VAT is charged at 20% on most goods and services, which you collect from your customers. This money does not belong to your business, it belongs to HMRC, and you are simply holding it until the deadline of your next VAT return.

We recommend setting aside the full 20% VAT into a separate savings account. Since VAT returns must be filed, usually every quarter, keeping this money separate means you can easily pay HMRC by each deadline without scrambling to find the funds.

What Taxes Should Small Business Owners Plan For?

Business owners often underestimate the range of taxes they may need to budget for. Your tax savings pot needs to account for more than just your income tax.

Here are some key taxes you should actively plan for:

• Income Tax: Payable on profits you make as a Sole Trader, or any salary, dividends and personal income above the Personal Allowance.
• National Insurance: Class 2 and Class 4 for the self-employed, and Class 1 for employers with staff.
• Corporation Tax: Payable on limited company profits at 19% to 25%, depending on profit levels.
• Value-Added Tax (VAT): Charged at 20% on most sales if the annual turnover of your limited company exceeds £90,000.
• PAYE and Employer National Insurance Tax: If you employ staff, you must deduct and pay these taxes to HMRC.
• Dividend tax: Payable on dividends above the £500 tax-free allowance, with rates from 8.75% to 39.35%.
• Payments on Account: Advanced payments made towards your next bill due in January and July.

How Many Tax Savings Accounts Do You Need?

This depends on your business structure but a simple approach works best for most small businesses and self-employed people.

We recommend minimum two separate accounts:

1. Business Savings account: For Income Tax, National Insurance if you are self-employed or a sole trader. For limited companies this also covers Corporation Tax. 
2. VAT account: If you are VAT registered, keep this money completely separate. 

If you are a limited company director, consider a third personal tax account for setting aside tax on dividends and other personal income. 

Simple Method to Calculate How Much to Save for Tax

You do not need complicated accounting software to calculate how much tax to start saving. We recommend a simple 6-step approach that helps keep your finances on track:

Step 1: Estimate your annual Income

Start by calculating your expected gross revenue for the tax year. You can use previous tax year’s figures as a baseline, or project forward based on your current monthly earnings.

Step 2: Deduct your allowable business expenses

Subtract all your allowable business costs from your total revenue. The figure you are left with is your estimated taxable profit.

Step 3: Apply your tax saving percentage

Once you have calculated your profit, apply the appropriate percentage based on your tax band. This gives you an estimated annual tax bill, which includes both your income tax and National Insurance.

Step 4: Break it down into monthly savings

Take your estimated annual tax bill and divide it by 12. This is the amount you should transfer into a separate tax savings account each month.

Step 5: Review and adjust every quarter

Since income fluctuates throughout the year, it is important to set a reminder to review your projections every three months. If your profits are higher than expected, increase your monthly savings.

Step 6: Factor in payments on account

Remember to check whether you owe any payments on account from the previous tax year, and plan ahead for payments on account for the coming year.

Common Mistakes To Avoid When Saving for Tax

We frequently see business owners and self-employed people fall into the same trap year after year. Knowing these few tips in advance can protect your cash flow:

• Saving based on turnover instead of profit: Your tax is calculated on profit, not total turnover. Saving from turnover will disturb your cash flow.
• Forgetting payments on account: Ignoring advance payments means your January bill can be 50% higher than expected, and you will most likely end up with a penalty.
• Spending VAT money: VAT belongs to HMRC, not your business. Treating it as income will create a cash flow shortage and leave you with no money to pay your quarterly returns.
• Not tracking expenses properly: Missed expenses mean a higher tax bill than necessary.
• Mixing business and personal accounts: This makes calculating your tax savings nearly impossible.
• Waiting until January to check your tax position: Leaving it till the last minute removes any room to adjust or save.
• Taking dividends without planning for personal tax: Directors often create a large personal tax bill with no funds set aside to pay it.

How an Accountant Can Help You Plan Ahead

We understand that calculating your tax bill can be stressful and risky. Getting professional support removes the uncertainty and saves you time to focus on running your business.

At Heighten Accountants, we can help you estimate your tax liability in real-time so you never face a surprise bill, and review your cash flow to ensure you are saving the correct amount each month.We minimize your overall exposure by planning your director salary and dividends optimally. 

Our accountants will identify any allowable expenses you might miss, review your VAT position, and set up a simple tax saving system that stops you from running out of cash before your deadline.