tax for the self-employed

More than one in seven people in work are self-employed. That means there are 4.8 million self-employed people in the UK, a rise of almost a quarter in just the last ten years.

While self-employment allows you to decide your own hours, work flexibly, and specialise in something you’re good at, it also means you have to look after your own tax and finances. Our guide everything you need to know about tax for the self-employed.

Income tax

If you work for yourself or run your own business, you have to register as self-employed with HM Revenue and Customs (HMRC). You should do this as soon as you can after starting your business in order for you to be able to complete a Self Assessment tax return and pay Class 2 National Insurance contributions (see below).

In order to work out how much tax you will have to pay, you are required to keep records of the money that comes into, and goes out of, your business. These records should include:

  • All your sales and earnings – for example cashbooks and invoices.
  • All your purchases and expenses – for example bank statements, receipts and mileage records.

In April each year, you will receive a letter from HMRC instructing you to complete a tax return for the tax year that has just ended.

Your tax return asks for all your earnings (i.e. sales you have made) and all the business expenses you want to claim. Your allowable expenses may include the cost of premises, the cost of raw materials, the running costs of premises, mileage, postage and wages for staff.

You can self-assess online, or complete a paper tax return. If you complete an online tax return you have until 31 January after the end of the tax year to submit your return. If you want to complete a paper tax return you have to submit this by 31 October after the end of the tax year.

You have to pay any tax that is due by 31 January following the end of the tax year. You also have a deadline of 31 July to make a ‘payment on account’ for the current tax year.

If you fail to submit your tax return on time, or you don’t pay your tax in time, you can face penalties and interest charges.

Often, you’ll find that several months can elapse between you sending in your tax return and the payment becoming due. It’s wise to make provision for any tax you owe so that you are in a position to pay your tax when it is due.

National Insurance

If you’re self-employed, you will probably need to pay National Insurance contributions (NICs) as well as income tax. Your NICs pay for benefits such as the state pension and maternity allowance.

You usually pay 2 types of National Insurance if you’re self-employed:

  • Class 2 (if your profits are £6,025 or more a year) at a rate of £2.85 per week.
  • Class 4 if your profits are £8,164 or more a year. The rate is 9% on profits between £8,164 and £45,000, and 2% on profits over £45,000.

Value Added Tax (VAT)

If you are self-employed, you will have to pay VAT if the turnover of your business is more than £85,000 (tax year 2017/18).

If you are VAT registered you have to charge the tax on all goods and services you supply that incur VAT. Almost everything comes under the 20% standard VAT rate although some items only attract 5% while others, such as food and children’s clothes, are zero-rated.

You can then reclaim any VAT that you have paid on goods and services that you have bought for your business. If you are not registered for VAT, you can’t reclaim this.

If you’re VAT registered, you have to complete a VAT return each quarter. When you complete your VAT return you tell HMRC how much VAT you have charged and how much you have paid. If you have charged more VAT than you have paid, you will need to make a tax payment.

If your turnover is less than £150,000 it is often worth considering the flat-rate VAT scheme. The scheme simplifies your accounting by calculating your VAT payments as a percentage of your VAT-inclusive turnover. It reduces admin and can represent good value for smaller businesses.

If your turnover is less than £85,000 you can still register for VAT voluntarily. This can be a good idea if you can claim a lot of VAT on items you buy for your business or if you want to show that your business is credible to potential customers or suppliers.