So you’ve decided to be your own boss - congratulations! You’ve joined the 5 million like-minded individuals in the UK taking the road less travelled. While the view is amazing, and most days you’ll feel on top of the world, the path to self-employment success is riddled with its own set of pitfalls.
Issues like increasing your client base, fulfilling orders to deadline, and staying in the black are common worries. However, there’s an Alpha Worry shaking most entrepreneurs awake at crazy o’clock.
For many of us, nothing looms larger than the shadow of the dreaded Self-Assessment deadline. This behemoth rears its ugly head at the close of your financial year - but it can lurk in the shadows all year long.
The good news is that self-assessment doesn’t have to be daunting. Having even a basic understanding of how self-employment tax works will eliminate a huge chunk of your worries.
In this post, we’ll shed light on some of the most frequently asked questions surrounding taxes for the self-employed.
1. How much income will I be taxed on?
You only pay income tax on your profits - not your gross annual income.
Additionally, you’re still entitled to the same personal allowance as those in employment. Here’s how it works:
2020/21 and 2019/20
Personal allowance: 0%
£0 to £12,500 you will pay zero income tax on your profits
Basic rate: 20%
£12,501-£50,000 you will pay 20% tax on your profits
Higher rate: 40%
£50,001-£150,000 you will pay 40% tax on your profits
Additional rate: 45%
Over £150,000 you will pay 45% tax on your profits
Image credit: moneyadviceservice.org.uk
Remember - if you’re currently employed (even if it's just part-time) alongside running your own business, your personal allowance will be used against your employment income first.
The good news to keep in mind here is that you’re only taxed on your profits. Considering the fact that most salaried employees are paying out expenses AFTER they’ve been taxed, you’re actually coming out on top!
Before you get carried away logging those new Airpods as a necessary business expenditure, you might want to check out this list of HMRC-approved expense categories.
Tragically, Netflix subscriptions don’t make the cut (we know - we checked!).
2. What counts as my gross income?
It’s pretty simple, really: anything you’ve invoiced a customer for (provided you received the payment, of course) counts as your income.
Make sure you’re using a recorded invoice/receipt system for every single transaction. Also, try and go digital with this process if you can. As retro as the old box of receipts might seem, logging your transactions digitally will save you (or your bookkeeper) a lot of time and hassle!
3. How do I calculate my profits?
Again, there’s no magic formula here. It’s all pretty basic maths.
1: Add up your total income (here’s where those invoices come in handy)
2: Add up your expenses (if you want more guidance on what you claim, check out our blog post on the topic)
3: Deduct expenses from income
And voila! You’ve got your profit figures.
If your revenue from your business is your only source of income, you won’t pay tax on the first £12,500.
4. How do I budget for income tax?
While the average 9-5 gig is clearly not your scene, being a PAYE employee does shift responsibility for income tax onto the shoulders of the employer. As annoying as it is to see a litany of deductions on your monthly payslip, at least it's one less thing to worry about.
Being self-employed means the employer is YOU (and the employee too, ironically...who says we can’t have it all?). One simple approach to ensuring you’re not caught out when the taxman comes knocking is setting aside a percentage of each sale as you go along.
A safe ballpark figure to slice from each win is 30%. Put this money directly into a separate account and, in the words of Gandalf, “Keep it secret - keep it safe”. This nest egg is your Ring of Power when December rolls around, and will ensure you can meet the tax deadline with confidence.
Besides income tax, there are other payments you may need to make to HMRC - depending on how much you’ve earned that year. You can use this calculator to get a rough idea of how much you might be liable for come April.
4. How should I file my self-assessment?
Completing a self-assessment is arguably the most stressful part of self-employment taxes. It’s fair to say that even the most savvy small business owners struggle to file on time. In fact, a whopping 950,000 people were late filing their tax returns for 2018-2019.