1. What does being self-employed mean?
Being self-employed is very different to being an employee.
Firstly, you are responsible for generating your own income and you must register with HMRC as being self-employed. If you are a freelancer, then typically you will be selling your services to other businesses or individuals. If you are running a small business, you may be buying and selling products and services to other businesses or individuals. In both cases, if you have not registered your trade as a business at Companies House, then you are operating as a sole trader on a self-employed basis. As a sole trader you can still employ other people, but when you do so you must also register with HMRC as an employer.
Secondly, you need to plan ahead as there are administration and reporting requirements that come hand-in-hand with being self-employed. If you have ever been an employee, then you will not have had to consider calculating your income tax and paying this to HMRC, as this is done through the PAYE (Pay As You Earn) system. However, as a self-employed person you are responsible for calculating and remitting your income tax and National Insurance Contributions (NIC) to HMRC. In addition, you won’t have any employment rights. For example, you will not receive holiday pay, statutory sick pay or pension contributions, so you will need to consider setting aside money to cover these things. In particular, you will need to set aside money to pay income tax and NIC.
2. Registering as self-employed with HMRC
You will need to let HMRC know that you are self-employed (if you will earn more than £1,000 from self-employment) and you will need to register for self-assessment and file a tax return each year.
If you have not filed a tax return in the previous year, you will need to register with HMRC by 5 October in your businesses second tax year. For example, if you started your business on 1 January 2019, you would need to register with HMRC by 5 October 2019.
Registering as self-employed is pretty easy and is done online.
3. What taxes you pay when you are self-employed
As a self-employed person, you will pay income tax and NICs at rates which depend on the profits from your business. Your profits are calculated based on your taxable income which is your total income less any deductible expenses.
3.1 Calculating your personal income tax
For the tax year 2019/2020, the income tax bands are:
|Band||Taxable income||Tax rate|
|Personal allowance||Up to £12,500||0%|
|Basic rate||£12,501 – £50,000||20%|
|Higher rate||£50,001 – £150,000||40%|
|Additional rate||Over £150,000||45%|
Note, that you do not get any personal allowance if your income is over £125,000.
3.2 Calculating your National Insurance Contributions
As well as income tax, you may also need to pay Class 2 and Class 4 National Insurance Contributions (NIC). For the tax year 2019/2020, you will pay:
Class 2 NIC if your profits are £6,365 or more a year
Class 4 NIC if your profits are £8,632 or more a year
The Class 2 and 4 NIC rates for the year 2019/2020 are:
|Class||Rate of NIC|
|Class 2||£3 per week|
|Class 4||9% on profits between £8,632 and £50,000
2% on profits over £50,000
4. Self-assessment and payment of taxes and NIC
Your self-assessment tax return is due to HMRC in the year following the tax year to which it relates. The tax year runs from 6 April to the 5 April in the following year. If you complete your self-assessment tax return on paper the deadline is 31 October. If you complete it online, then the deadline is 31 January.
You will pay your tax for the year in two instalments (each payment is 50% of your previous year’s tax bill), followed by a top up instalment if there is any outstanding tax due. The due dates are:
- 31 January
- 31 July
For the year 2019/2020 the tax payment dates would be 31 January 2020 and 31 July 2020, with any top up payment due 31 January 2021.
Class 4 NIC is due with your income tax instalments and Class 2 NIC is usually paid when the top up payment is made (i.e. by 31 January in the following tax year).
If your tax is less than £1000 then you will be required to pay it by the 31 January. When your tax bill is over £1000, HMRC will require you to pay your tax bill in advance via two instalments. The first instalment is due on the 31 January and the second on the 31 July. There is more information on HMRC’s website about payments on account.
5. Agreeing work with clients
It is recommended that you formalise agreements with your clients and customers in writing, that way both parties will know where they stand when it comes to deliverables, timetables, responsibilities and importantly payments.
If you are going to provide similar services to several clients, having a standard contract or wording for general terms and conditions, is a good idea. The exact scope of work and prices can then be agreed separately for specific clients and/or projects, but the general terms and conditions are always the same. So long as your general terms and conditions allow you to agree changes, you can modify them (e.g. you may give some clients 7 days to pay and others 30 days).
Contract templates are available from Business Clan and elsewhere online. If purchasing online it is advisable to check that they are appropriate for your business and that you don’t make any changes without checking that the clauses are legally correct.
6. Getting paid and issuing invoices
Now you have the clients and agreed the terms of the services you will provide, you will need to think about invoicing them. There are a number of free templates and software packages around which you can use or you may want to consider an accountancy software package such as QuickBooks, Xero or Zoho Books which will make your bookkeeping quicker and simpler to do. Whatever you choose (and there is no reason why you can’t create an invoice in Word or Excel), it is important that your invoice includes a number of things like your name and the client’s name and address, the date, the services provided, the amount and, if applicable, VAT. Having your payment terms on your invoice, as agreed with the client, will help in receiving prompt payment for your services.
7. Do I need to charge VAT?
You only need to charge VAT on your products and services when your VAT taxable turnover reaches the VAT registration threshold, which is currently £85,000 per annum. More information can be found on HMRC’s website: VAT registration.
8. What are deductible expenses
In running your business, you will incur costs which may be deductible against your income.
Whether costs are deductible will depend on whether they have been incurred “wholly and exclusively for the purposes of the trade”. This means, you will need to identify expenditure which has been incurred for business purposes.
Examples of deductible business expenditure are: accounting fees, business travel, stock, printing and stationery. You may also be able to claim for capital expenditure (e.g. computers, tools, vehicles) but the deductibility of these will depend on the level of expenditure and the specifics of the capital spend.
Sometimes expenses can have a dual purpose. A good example is where you use a mobile phone for both personal and business use. In these cases, you may need to consider apportioning expenditure between personal and business use.
9. Record keeping
You must maintain and keep accurate business records. These are sometimes referred to as sole trader accounts. Records that you need to keep include: copies of all invoices issued, receipts of all expenses you are claiming a tax deduction on and also copies of your bank statements. You will need all this information to help you prepare your self-assessment tax return at the end of the tax year.
These documents should be retained for a period of six years. In addition, HMRC can ask for supporting information for figures and calculations in your self-assessment tax return, so it’s a good idea to keep your books in good order.
If you are registered for VAT you will also need to ensure you maintain accurate VAT records.
If you employ people, then there will be additional requirements for PAYE, record keeping, and personnel administration. Our article on becoming an employer, payroll and taking on employees provides further information.
10. Other things to consider
- Keep a separate bank account – this will make it easier to identify business profits. It will also make it easier to track your client receipts and to do bank reconciliations.
- Monitor your profits and estimate your taxes and NIC – doing this on a monthly basis will allow you to ensure you have the funds to pay your tax liabilities as they become due.
- Set aside additional funds for times when you are unable to work e.g. due to sickness or when you want to go on holiday. It is a good idea to consider your pension position too.
- Research software for small businesses – various software packages can help you with things from bookkeeping to stock control. We offer our clients special deals, so please get in touch to find out more.
- If you only have one client or do regular work for one client, then consider the IR35 rules and whether you should be considered an employee rather than be self-employed. If in doubt, seek advice.
- Student loans – if you have a student loan you must tell HMRC about any student loan deductions, in your self-assessment tax return. Depending on the level of your income, you may have to repay 9% of your total income in student loan repayments.
Sarah Boothroyd, Chartered Accountant & Tax Adviser
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