Are you involved in any work, side hustles, or hobbies that generate income outside of your regular employment?
Do you anticipate an increase in your income from this work?
If you answered yes to these questions, there is a possibility that you are self-employed! You may on the path to becoming an influencer, or in the throes of establishing a start-up business. Whichever your path, understanding, filing, and paying taxes on your earnings are crucial aspects of being self-employed.
This often leads to the common question: how does self-employment tax work? Unfortunately, this can be a very complex and confusing topic for many individuals. To address the question, we have created this blog post to provide clarity and demystify some of the intricate regulations of the UK system. Continue reading to gain a better understanding of how working for yourself is taxed.
This post covers:
To understand how much tax and National Insurance you need to pay, you need to understand if you're employed, self-employed, or even both. There is no decisive test that exists to answer this question however, you can consider yourself in self-employment if:
The above means you can potentially be employed, and self-employed, at the same time. You may for example work for your employer from 9am to 5pm, from Monday to Friday, but then have a side hustle as an influencer, which you work on in the evenings and over the weekends.
You can use HMRC's, 'check your employment status' service to help you work out your status based on answering their questions. This is indicative however, it won't provide you with an absolute answer.
When you're self-employed you don't pay income tax on your total income, instead it is applied to your trading profits. This means if your income is greater than your expenses then the profit that is left is the amount that may be subject to income tax.
If your self-employment income is greater than £1,000 for the tax year, then you need to register with HM Revenue & Customs (HMRC) as self-employed by 5 October following the end of the tax year in which your income commenced.
You have 3 options by which you can register either online, by phone, or by post. You'll need to provide:
Your online Government Gateway account will be set up and after about 10 days you'll also receive a 10-digit Unique Taxpayer Reference, known as a UTR. You'll then have access to a multitude of government services.
As part of this process you'll need to decide on a name for your business. Be sure to check carefully that there aren't any existing businesses with the same name as the one you've selected. This could lead to copyright infringement!
Being self-employed is a label in that you're not employed by another person, or entity. If you work for yourself, and you're on your own doing it, and this is likely to remain a lower revenue business, this may mean that you're a self-employed worker classified as a sole trader.
If you're new to self-employment, you're not sure how long you're going to do this for, or whether this will scale into a big business then sole trader will potentially work for you.
Alternatively, if you're part of a business partnership then you won't be a sole trader, you'll register as self-employed and have to provide details of the partnership you have joined. Click on the link to find out more about the different types of business structures.
Once you're registered, it's important you realise that your tax and National Insurance are no longer deducted from your earnings at source, as they are when you're employed through Pay as You Earn (PAYE).
Instead, you're responsible for paying your own taxes. This means you have to prepare a tax return, and the amount you owe HMRC is calculated based on the figures you provide. We recommend preparing your tax return as soon as possible to gauge how much you owe long before the 31 January filing deadline.
Doing so promptly should then provide you with ample time to set sufficient money aside to budget for the tax liability you will owe. This all also highlights the essential need to keep your income and expense records up to date to ensure you complete your tax return accurately.
You have an income personal allowance of £12,570 which is the amount you can earn before you have to start paying tax.
Then dependent on your earnings, you'll fall into one of the following tax bands (see table below) and the relevant income tax rate is applied.
| Income tax band | Income tax rate |
|
Personal allowance Up to £12,570 |
0% |
|
Basic-rate £12,571 - £50,270 |
20% |
|
Higher-rate £50,271 - £125,140 |
40% |
|
Additional-rate > £125,140 |
45% |
Of note, if your earnings exceed £100,000 then your personal allowance is reduced by £1 for every £2 that you're above this level of income. Should your earnings be in excess of £125,140 then you lose the personal allowance altogether. This in turn means the effective rate of tax on your earnings in the £100,000 - £125,140 range can rise to 60%.
Dependent on your current and likely future earnings, it may make sense for you to register as a limited company. This could be a particularly pertinent option if you see your business expanding whereby turnover rises, you eventually locate to a premises, and take on employees. Operating through a limited company can provide tax benefits and protection from creditors (entities your business owes money to).
However, it also comes with the added burden of more reporting requirements such as filing accounts, and declaring dividends to name a few, so it's probably wise to seek professional advice on if it's worth pursuing, and how to best manage it.
You are entitled to claim certain deductions from your income in respect of specific expenses you may have incurred in conducting your trade. Using these expenses to help lower your taxable income then potentially reduces your tax bill. Consider the following carefully as part of this:
Do you use space in your home for work purposes? If so then you may be able to claim a proportion of some of your home office expenses. Of note, claiming home office expenses on a property that is your 'principle private residence' could have an impact on any capital gains tax reliefs available to you should should you subsequently come to sell the property.
If you use certain tools, equipment, and software services such as laptops, computers, cameras, and phones to name a few, then these are deductible so long as they are used exclusively for business purposes.
If you make use of professionals such as lawyers, accountants, social media managers, or videographers, then their fees can potentially be classified as business expenses. Be careful with how you record such expenditure.
Perhaps you attend conferences or events? Do you have to travel for business purposes? Airfares, taxis, car rental, fuel costs, train tickets, meals, property rental, and hotel rooms are all potential deductions to be made.
Have you invested in your own professional development through some form of education, or training? Things such as workshops, courses, seminars, and conferences that help enhance your skills and knowledge are likely to be applicable for deduction.
Subscriptions, stationary, postage, website hosting costs, and bank and shipping fees are all worth investigating.
To promote your business do you incur expenses for website creation, social media adverts, pay per click advertising, search engine optimisation, collaborations, or promotional items? If so, these could be tax deductible.
Your wages, or drawings, aren't tax deductible. If your spouse works in the business however, their wages are considered allowable so long as they are paid and considered a reasonable reward for what is done.
The UK tax year is different to the calendar year, it commences on 6 April and finishes on 5 April of the following year. If you're new to self-employment, or in a partnership, then you will be taxed from the point you started trading to the end of the tax year.
Basis period reform means if you're an existing sole trader, or in a partnership, who have previously been taxed to your account’s year end, this will be transitioned to being taxed to 5 April during the 2023/24 tax year, or 31 March in instances where your accounts are drawn up to that date.
As mentioned earlier, you have to submit a self assessment tax return detailing you income for the tax year in questions that ends on 5 April. This must be submitted to HMRC by 31 October deadline for paper returns, or 31 January in the case of online returns. The return should also include where relevant any gains you may have made from the sale of assets that result in you being liable for capital gains tax.
You make payment through a mechanism known as payment on account. This is for income tax and National Insurance contributions (NICs), with the due date also falling on 31 January for first payment on account, and the balancing payment, and 31 July for second payment on account.
The balancing payment is any balance of tax owed for the year under assessment minus the 2 payments on account made in the prior year towards that liability. You can however, reduce payments on account if you think your income will be lower compared to previously.
If you fail to make payment on time then you run the risk of penalties and interest being applied to the amount due.
National Insurance contributions (NICs) are another form of tax on your earnings that help build your entitlement to certain benefits such as the state pension and maternity allowance. Being self-employed, you are subject to a two-tier system of national insurance contributions (NICs).
Class 2 NICs apply if your earnings exceed £6,475 per year and they're charged at a flat rate of £3.05 per week.
Class 4 NICs are applied to profits between £9,500 and £50,000, at a rate of 9%.
If your profits exceed £50,000, then you're subject to Class 4 NICs at the rate of 2% and there's no upper limit.
Class 2 and 4 NICs are collected by HMRC at the same time as the installments of income tax through the payment on account system.
It is essential that you set sufficient money aside so that you can make payment of your Income Tax and NICs liabilities on 31 January and 31 July. Fail to do this on the due dates and you'll incur interest on the unpaid tax.
There exists in the UK something called cash basis accounting for small businesses. It is a potentially simplified method to help you calculate tax owed and reduce your administrative burden.
It works whereby you only pay tax on money when it is received, as opposed to when it is invoiced. This means income and expenses are only recorded when they are settled, namely when money changes hands. Invoices, or bills, that haven't been paid yet don't count.
This is as opposed to accrual basis accounting whereby income is recognised once an invoice is raised. When it comes to bills, these are recorded as an expense when they come in even if payment won't be made for several days, or weeks.
Cash basis accounting also means you don't have to compile figures of debtors, creditors, and stock, and you don't need to distinguish between ‘capital’ and ‘revenue’ expenditure. Whilst the simplicity will be welcomed by many, there are flaws as well, namely:
The content of this post was created on 22/09/2023.
Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.
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