Avoid the trading allowance trap

NI and self-employment

When you become self-employed many obligations fall on your shoulders. You may have familiarised yourself with the income tax rules but NI is a different beast. Not paying income tax is great but if for any year you don’t have a full NI record it won’t count towards your state pension.

It’s all about class

If you’re self-employed or a partner in a business, you pay Class 4 NI on your annual profits above £12,570. This is usually also the point at which you start to pay income tax. In addition, Class 2 NI used to be payable but it was abolished from April 2024. However, there is a good reason to consider paying voluntary Class 2 NI if your annual profits are equal to or lower than the small profits threshold (SPT) (£6,845 for 2025/26 and £6,725 for 2024/25).

If your annual profits are more than the SPT. As we’ve already said, you don’t pay any NI (or usually tax) but are treated as if you have paid Class 2 NI for the whole year. This means that it counts as a qualifying year for your state pension.

If your annual profits are less than the SPT. This won’t count as a qualifying year for your state pension unless you’re entitled to NI credits, say because you have young children. To make it a qualifying year you must pay voluntary Class 2 contributions. At the current rate they cost £3.50 per week (£182 per year).

You can pay voluntary contributions for up to six previous tax years. This means you don’t have to decide whether to pay them until you’ve worked out your annual profits (see Further information ).

Trading allowance

If your business turnover is low and your business expenses less than £1,000 you might save tax by claiming the trading allowance instead. This reduces your taxable profit by up to £1,000 and applies automatically if your turnover is less than this. If your turnover is greater the allowance must be claimed if you want to deduct it.

If the trading allowance reduces your profit to below the SPT you’d lose the automatic free NI credits. In this situation you can be better off not claiming it.

Example. Emma is a self-employed tutor, which is her only source of income. Her turnover for 2024/25 is £7,200 and her tax-deductible expenses, £500. Emma could choose to claim the trading allowance of £1,000 instead of her expenses. If she did her taxable profits for the year would be £6,700 and she’d lose her entitlement to the free NI credits. Therefore, she shouldn’t claim the allowance. What’s more, as her total income is below £12,570 she isn’t liable to income tax on her profits and so claiming the trading allowance doesn’t save tax.

If your turnover is only slightly more than the lower profits limit for a year and your tax-deductible expenses are less than £1,000, consider claiming the trading allowance instead. But only if doing so reduces your income tax by more than the amount you would have to pay in voluntary Class 2 NI contributions to make the year count towards your state pension.