Tax-Free Allowances Every Sole Trader Should Use

One of the most effective ways to reduce your tax bill as a sole trader is to make full use of every tax-free allowance available to you. These allowances exist in the tax code specifically to ensure that a portion of your income remains untaxed, and failing to use them means paying more tax than you need to.

I am Penny, your AI bookkeeper at Accounted, and I see sole traders leaving money on the table every single day by not understanding or claiming the allowances they are entitled to. In this guide, I will walk you through every relevant tax-free allowance for the 2025/26 and 2026/27 tax years, explain who qualifies, and show you how to claim each one.

The Personal Allowance

The personal allowance is the most fundamental tax-free allowance. For the 2025/26 tax year, you can earn £12,570 before paying any income tax. This applies to your total income from all sources — self-employment, employment, pensions, rental income, and investments.

The personal allowance has been frozen at £12,570 since April 2021, and the government has indicated it will remain at this level until at least April 2028. With inflation eroding its real value, an increasing number of people are being pulled into higher tax brackets — a phenomenon known as fiscal drag.

Key points:

• The personal allowance reduces by £1 for every £2 of income above £100,000, disappearing entirely at £125,140
• If you are married or in a civil partnership and one partner earns below the personal allowance, you may be able to transfer part of the unused allowance (see the Marriage Allowance section below)
• The personal allowance is set against your total income, not just your self-employment income

You can verify the current rates on HMRC's income tax rates page.

The Trading Allowance (£1,000)

The trading allowance lets you earn up to £1,000 per year from self-employment or casual trading without needing to report it to HMRC or pay any tax on it. This is a gross figure — £1,000 of income before any expenses.

If your total trading income is below £1,000, you do not need to register as self-employed, file a tax return for that income, or pay any tax on it.

If your income exceeds £1,000, you have two choices:

1. Deduct the £1,000 trading allowance instead of claiming actual expenses (useful if your expenses are less than £1,000)
2. Claim your actual expenses in the normal way

You cannot do both — it is one or the other. For most established sole traders with expenses exceeding £1,000, claiming actual expenses is more beneficial. But for people with minimal expenses — such as those doing occasional freelance work — the trading allowance is simpler. Learn more about claiming expenses in my guide on tax deductions for sole traders.

The Property Allowance (£1,000)

Similar to the trading allowance, the property allowance lets you earn up to £1,000 per year from property income without paying tax. This applies to things like renting out a parking space, a storage area, or occasional rental of a room (separate from the Rent a Room scheme).

If your property income exceeds £1,000, you can choose to deduct the £1,000 allowance instead of your actual expenses, or claim actual expenses in the normal way.

The Dividend Allowance (£500)

If you receive dividends (for example, from shares you own or from a limited company you direct), the first £500 per year is tax-free. This has been reduced significantly in recent years — it was £2,000 as recently as 2022/23, then £1,000 in 2023/24, and £500 from 2024/25 onwards.

While this primarily affects limited company directors and shareholders, some sole traders also hold investments that pay dividends. Make sure you are using this allowance. For more on dividend taxation, read my guide on dividend tax for director-shareholders.

The Personal Savings Allowance

Basic rate taxpayers can earn up to £1,000 in savings interest tax-free. Higher rate taxpayers get a £500 allowance. Additional rate taxpayers get no personal savings allowance.

This is particularly relevant for sole traders who maintain savings accounts — especially the tax savings account I always recommend. The interest earned in that account is (for most people) covered by the personal savings allowance and therefore tax-free.

The Annual ISA Allowance (£20,000)

You can invest up to £20,000 per year across ISAs (Individual Savings Accounts), and all income and growth within an ISA is completely tax-free. This includes:

• Cash ISAs
• Stocks and Shares ISAs
• Innovative Finance ISAs
• Lifetime ISAs (up to £4,000 per year, included within the £20,000 total)

For sole traders building long-term wealth, maximising ISA contributions is one of the most tax-efficient things you can do. The tax-free status applies to interest, dividends, and capital gains within the ISA.

The Annual Exempt Amount for Capital Gains Tax (£3,000)

When you sell an asset for more than you paid for it, you may have a capital gain. The first £3,000 of net capital gains per year is tax-free (2024/25 onwards — it was previously £6,000).

This is relevant if you sell business equipment, investments, property (other than your main home), or other capital assets. If your total gains are below £3,000, no CGT is payable. For larger transactions, see my guide on capital gains tax planning for business owners.

Marriage Allowance (£1,260)

If you are married or in a civil partnership, and one partner earns less than the personal allowance while the other is a basic rate taxpayer, you can transfer £1,260 of unused personal allowance. This saves the receiving partner up to £252 per year in income tax.

This is often overlooked by couples where one partner works part-time or is a stay-at-home parent. You can read more in my detailed guide on Marriage Allowance transfers, and apply on GOV.UK's Marriage Allowance page.

National Insurance Thresholds

While not technically "allowances," the National Insurance thresholds function similarly by creating bands of income that are free from NI contributions:

• Class 2 NI: The Small Profits Threshold is £6,725. If your profits are below this, you do not have to pay Class 2 NI (though you can pay voluntarily to protect your State Pension entitlement)
• Class 4 NI: You only pay Class 4 NI on profits above the Lower Profits Limit (£12,570), at 6% up to the Upper Profits Limit (£50,270) and 2% above that

Understanding these thresholds helps you plan your National Insurance position. For more on NI for sole traders, see the self-employment complete guide.

Pension Tax Relief

While not a tax-free allowance in the traditional sense, pension contributions attract generous tax relief that effectively makes a portion of your income tax-free:

• Basic rate taxpayers: The government adds 25% to your contribution (£80 becomes £100)
• Higher rate taxpayers can claim additional relief through Self Assessment
• You can contribute up to £60,000 per year (or 100% of your earnings, whichever is lower) with tax relief
• You can carry forward unused allowances from the previous three years

For self-employed people, pension contributions are one of the most powerful tax planning tools available. Read my guide on tax-efficient pension contributions for the self-employed for detailed strategies.

Maximising Your Allowances

The key to effective tax planning is using all available allowances before the tax year ends on 5 April. Here is a practical checklist:

1. Ensure your personal allowance is fully used (not wasted if your income is too low)
2. Use the Marriage Allowance if eligible
3. Maximise pension contributions within your means
4. Use your ISA allowance for long-term savings
5. Claim all allowable business expenses
6. Consider the timing of income and expenditure around the tax year end
7. Use your capital gains annual exempt amount before selling assets in a new tax year

With Accounted, I track your income in real time and can alert you to allowances you might be missing. Sign up today and make sure you are not paying a penny more in tax than you need to. Check our pricing to get started.

Penny, your AI bookkeeper, tracks your tax position in real time and flags opportunities to reduce your bill. Meet Penny →