Setting Aside Money for Tax
Use simple set-aside rules and a tax savings account so your VAT, Income Tax and Corporation Tax bills never surprise you.
The money in your business bank account is rarely all yours. A meaningful slice belongs to HMRC and is simply waiting in your account until a deadline arrives. The single most common reason small businesses panic in January, or scramble before a VAT quarter ends, is that they spent money that was always earmarked for tax. Setting money aside as you earn it turns a frightening lump-sum bill into a non-event. This guide explains how much to put by for Income Tax, National Insurance, VAT and Corporation Tax, and how to make the habit automatic.
Why set money aside
Tax is not an unexpected cost. It is a predictable percentage of profit or sales that you know is coming months in advance. The problem is timing: you receive income continuously, but you pay tax in occasional large chunks. When the gap between earning and paying is long, it is tempting to treat the full balance as available to spend.
Putting money aside as income arrives solves three problems at once. You avoid borrowing or dipping into overdrafts to cover a bill, you keep an honest picture of what your business can actually afford, and you remove the year-end stress entirely. It also pairs naturally with good cash flow forecasting basics so you always know what is genuinely free to reinvest.
Estimating Income Tax and National Insurance
If you are a sole trader, you pay Income Tax and National Insurance on your business profit, not your turnover. Profit is your income minus your allowable business expenses , so the first step is keeping clean records of both.
A practical approach is to estimate your effective tax rate across the year and apply it to profit as you go. Because the UK uses banded rates, your effective rate is usually lower than your top marginal rate, especially once your tax-free personal allowance is taken into account. Until you have a clear picture, it is safer to over-reserve than under-reserve.
Key points to remember:
- You are taxed on profit, so set aside a percentage of profit, not of every invoice.
- Your first Self Assessment can feel large because it may include the prior year plus advance payments.
- See our Self Assessment step by step guide for the full filing process.
Setting aside for VAT
VAT is different in character from income taxes: the VAT you charge on sales was never your money at all. You are collecting it on behalf of HMRC and will hand most of it over, minus the VAT you reclaim on your own purchases.
The cleanest rule is to move the VAT element of every sale into your tax account the moment you are paid. If you charge the standard rate on an invoice, set aside that portion immediately and treat the rest as your real income. Doing this prevents the classic trap of spending VAT-inclusive cash and finding the quarter-end return unaffordable. Our guide to managing VAT cash flow covers the timing in detail, and the cash basis versus accruals choice affects when VAT becomes due.
Setting aside for Corporation Tax
If you run a limited company, the company pays Corporation Tax on its profits. As the company earns, set aside a slice of profit so the bill is fully funded by the time it is due, several months after your accounting period ends.
A useful discipline is to calculate a rough Corporation Tax provision at the end of each month and ring-fence it. This keeps your distributable profit honest, which matters when deciding salary versus dividends or extracting profit tax-efficiently . Paying yourself dividends out of money that is really earmarked for tax is one of the easiest ways to create a shortfall.
A separate tax savings account
The simplest, most reliable tool is a separate tax savings account. Out of sight is out of mind: if the money never appears in your day-to-day balance, you cannot accidentally spend it.
A clean structure looks like this:
- A current account for trading income and expenses.
- A dedicated tax account where you transfer set-aside amounts.
- Optionally a separate pot for VAT and another for Income Tax or Corporation Tax, so you can see each obligation building up.
Many business accounts let you create sub-accounts or “pots” at no extra cost, making this effortless. Where possible, choose an account that pays a little interest, so your reserved tax money works gently for you until the deadline.
Percentage rules of thumb
Rules of thumb are not a substitute for a proper calculation, but they keep you safe between reviews. Adjust the figures to your own situation and lean towards setting aside slightly more than you expect to owe.
| Business type | Set aside from | Typical starting point |
|---|---|---|
| Sole trader | Profit | A conservative share of profit for Income Tax and National Insurance |
| VAT-registered | Each VATable sale | The full VAT charged, reduced later by reclaimable VAT |
| Limited company | Company profit | A provision at the applicable Corporation Tax rate |
The exact percentages depend on your profit level, your VAT scheme and the current rates. Review your set-aside rate at least quarterly, and recalculate whenever your income changes significantly. If you choose the Flat Rate Scheme, your effective VAT position differs, so revisit choosing the right VAT scheme before fixing a percentage.
Adjusting for payments on account
Sole traders often face payments on account: advance instalments towards next year’s Income Tax bill, based on the current year. The result is that your first big tax payment can be roughly one and a half times the tax actually due for that year, which catches many people out.
Build this into your set-aside rate from day one. If you reserve only for the tax on profit earned, you may still fall short when the advance payments land. Our payments on account explained guide shows how the instalments are calculated and when they fall due, so you can reserve the right amount rather than guessing.
Automating the habit
The goal is to make setting aside money for tax something that happens without willpower. Manual transfers work, but they fail the moment you are busy.
Ways to automate it:
- Set a standing order that sweeps a fixed amount into your tax account each week or month.
- Use banking rules or pots that automatically route a percentage of incoming payments.
- Connect your bookkeeping so your live tax estimate updates as you invoice and record costs, using tools covered in automating your bookkeeping .
With Making Tax Digital pushing more businesses towards real-time records, an always-current view of what you owe is increasingly the norm. The more visible your tax liability is, the easier it is to keep the right amount aside and the harder it is to fool yourself about what you can afford.