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.
Even with an entirely digitized process, it can still feel like you’re leaping through an obstacle course of flaming hoops and ever-shifting goalposts. The number of people outsourcing this unsavory task to accountants is growing every year. Of course, this doesn’t mean YOU have to (although we’d love to take the stress off your hands).
Below is a basic breakdown of how you can stay one step ahead of looming deadlines and get your return filed on time!
If you’re newly self-employed:
If this is your first foray into the wonderful world of entrepreneurship, you’ll need to register as self-employed with HMRC. Once you’ve done so, you’ll receive a letter within 10 days with your UTR (Unique Taxpayer Reference). A second letter will be sent with your activation code. As soon as you get these numbers, you’ll all set to file online!
Whatever you do, do NOT lose these details. Getting a new one can be a massive headache and, if left too late, can mean you’ll miss the deadline. Take a snapshot and save it to your digital notepad as opposed to jotting it down on paper (which can get lost or damaged).
If you’ve already registered:
Dig out that UTR (the one you wrote down and forgot where you wrote it and spent hours tearing the house apart and then found it down the back of the sofa...never happened to you? Our bad). Login to your online account with HMRC. Once you’ve done that, you’ll be sent an activation code (yes, ANOTHER one). Then it’s just a question of inputting all the data you’ve been collecting throughout the year
If you’re planning on changing industries or business models, you’ll need to re-register your self-employment. Fill out a CWF1 form online using your original UTR (you’ll need another activation code to do this, so make sure you leave yourself enough time).
4. When do I need to file my self-assessment?
We all know how easy it is to let deadlines creep up on us like sneaky little ninjas. We make a note of it on our calendars and set ourselves reminders. We even pay homage to our excellent time management skills by proclaiming loudly “big day tomorrow, gotta get a jump on X project before Thursday” (while binge-watching Bake-Off episodes).
When it comes to self-assessment, the sooner you file, the better. As we’ve established, the process isn’t as straightforward as it seems. The bigger your time buffer, the lower your stress levels will be.
The deadline for paying your tax bill (plus your first amount for the following year) is the 31st of January. However, you can file your assessment from the day after the tax year ends - typically the 5th of April. While you won’t have to actually pay anything until January the following year, filing early means you’ll have a clear projection of the amount you’ll owe. This gives you the rest of the year to budget accordingly.
If you’re filing early, remember that HMRC will calculate the amount you owe based on the figures you’ve provided. If you end up overpaying, HMRC will notify you and refund you the difference relatively quickly (I say ‘relatively’ - after all, it’s HMRC). You can bank the extra cash, put it towards the following year’s tax, or treat yourself to a well-deserved spending spree.
5. Should I outsource my tax management?
We’re not here to tell you what to do. After all, one of the perks of self-employment is that YOU’RE in charge!
Running your own business takes guts, dedication, patience and intelligence. Whether it's filing a self-assessment, applying for a loan, or balancing your checkbook, one thing’s for certain: you have what it takes to carry your business to success - and that includes the grit to take HMRC by the horns once a year.
But just because you CAN, it doesn’t mean you HAVE to. There’s lots of things we’re all perfectly capable of doing, yet choose to outsource. For example, we could make a coffee at home, but picking one up on the way to work is easier (plus, they have all those extra milk options). We could argue with our partners about emptying the rubbish, but paying a reliable cleaner to sort it means our bins will be out on the curb the night before the council show up (or don’t, depending on if there’s a light dusting of snow…).
We make these choices based on how much effort and time doing it ourselves will cost us, versus how much money we’ll spend offloading it to someone else.
Addition offers full-suite financial services to small businesses and startups - from bookkeeping to growth funding. Our tailored plans grow with your business, eliminate the need for a full-time finance team, and give actionable insights to get you further, faster! Hop on a call and let us make it all add up.