Making Tax Digital: What Sole Traders Need to Know

With the 2026 self-assessment tax return deadline now passed, the transition to Making Tax Digital for Income Self-Assessment (MTD for ITSA) is underway.

Rob Rees, Divisional Director at Markel Direct

From April 2026, as part of the government’s plans to modernise the tax system, self-employed business owners with a qualifying income exceeding £50,000 will switch from submitting an annual tax return to providing quarterly updates.

Here, Rob Rees, Divisional Director at business insurance specialist Markel Direct, breaks down these new tax rules affecting sole traders and provides guidance on how to best prepare.

What is Making Tax Digital for Income Tax Self-Assessment?

HMRC is moving towards quarterly tax reporting to improve the accuracy and efficiency of tax for income tax self-assessments. The initiative is currently mandatory for all VAT-registered businesses. However, the proposed changes will see the initiative expand to income tax for self-employed individuals with qualifying incomes over £50,000 from April 2026, and over £30,000 from April 2027.

MTD for ITSA will require sole traders to:

• Keep digital records of income and expenses.
• Use HMRC-compatible software for submissions. Spreadsheets and manual uploads will no longer be acceptable.

According to the government’s projections, about 780,000 people will be affected by this threshold based on their income reported in the 2024/25 tax return. The rules for those earning under £30,000 are still being reviewed, but they can choose to sign up voluntarily.

What Does this Change Mean for Small Businesses?

In addition to moving from one tax return per year to one every quarter, which is followed by a final end of year declaration, the initiative will also impact how sole traders manage risk.

Common issues with tax returns include poor record keeping, late submissions and inaccurate figures, and under MTD for ITSA they could still persist if systems aren’t set up correctly.

Simple things, such as a missed update, broken software link or incomplete data feed could create problems that snowball over time if not addressed. For SMEs where owners often handle finances themselves, this can increase exposure to:

• Late filing penalties
• Incorrect tax payments
• Cash-flow surprises caused by inaccurate reporting
• Admin stress during audits or HMRC checks

Making Tax Digital Risk Considerations for SMEs

As the move to MTD for ITSA requires more dependency on technology, data and ongoing processes, rather than annual paperwork and receipts, the type of risks that small businesses encounter are also changing.

Greater Reliance on Software and Data

Digital processes are replacing paper records and manual submissions, with small businesses expected to use compatible software to report their figures. However, if systems fail, links break between platforms, or data is corrupted, businesses may struggle to submit accurate information on time.

These potential issues highlight the importance of making regular back-ups and taking the time to understand both the accounting software and reporting requirements, reducing the likelihood of issues being caused by human error.

Cyber and Data Security Exposure

Tax return records contain sensitive financial and personal information, and with the shift to a digital landscape where data will now be transferred between systems, the risk of cyber incidents, accidental data loss or ransomware increases.

Due to the tax submissions changing to quarterly (from the current once a year), there is potential for disruptions to have a greater impact. For example, if tax return self-assessment submissions were delayed due to a cyber incident, system outage or lost records, businesses could potentially face penalties or unexpected tax adjustments. For SMEs, this could have a drastic impact on cash flow and day-to-day operations.

Not Being Prepared for the Change

The most immediate risk to SMEs is not being prepared for the change to MTD for ITSA, as late submissions will ultimately lead to financial penalties.

HMRC is applying a points-based approach to penalties; each missed quarterly update will result in 1 penalty point, with 4 points triggering a £200 fine. After this threshold, each missed update will result in another £200 fine.

As there will be five submissions in total per year (quarterly, plus one annual declaration), and points only reset after 24 months of compliance, the cost of missing submissions could result in costly fines for SME owners.

The Digital Pivot: How to Prepare for the Switch

Tax returns can be daunting for any business, especially for sole traders, freelancers and landlords who might manage their tax affairs without the help of an accountant. Here are five key takeaways to consider ahead of the transition.

1. Check Software Compatibility

Not all accounting tools are compatible with MTD for ITSA. Sole traders should ensure that their bookkeeping or accounting software is HMRC-compatible and capable of submitting data directly. If not, it should be changed promptly. SME owners who manage their own taxes should also ensure they are familiar with the software and the reporting requirements.

2. Build Tax into Routine Operations

Due to the quarterly submissions, it is recommended that businesses view the tax process as ongoing. Monthly reviews of figures help reduce errors, improve visibility and support better cash-flow forecasting.

3. Review How Records are Kept

If income and expenses are still tracked manually, these should be moved into a digital system. HMRC requires records to be kept digitally and transferred via ‘digital links’, rather than copied and pasted between systems. Doing this now will help streamline submissions

4. Assign Responsibility

Whether it is the business owner, or an external accountant, someone must own responsibility for submissions and software maintenance. This will reduce the likelihood of errors caused by confusion or duplication.

5. Upgrade Cyber Defences

As tax reporting becomes digital, exposure to cyber incidents increases. SMEs should review whether basic cyber security protections and procedures are in place, such as anti-virus software, strong passwords, regular software updates and secure backups, to reduce the risk of disruption, data loss and delayed submissions.

With the transition to Making Tax Digital fast approaching, it is essential for sole traders to prepare accordingly. Becoming proficient with accounting software compatible with Making Tax Digital, ensuring thorough expense documentation, and clearly understanding reporting requirements are all critical measures to prevent unforeseen penalties.

>> Read more about Making Tax Digital in the news