While going into business to work for yourself is an exciting time, there will be a lot you will need to consider. Self-employment means you will be taking on many responsibilities in the course of running your business, including meeting your tax obligations.
What is self-employment status?
If you start to work for yourself, you will be classed as a sole trader – whether or not you inform HMRC. Being self-employed, you will have to complete an annual Self-Assessment return and pay taxes.
There is no legal definition of self-employment, meaning your status will be determined by the circumstances; it is not a choice you can make or a box you can choose to tick.
In terms of tax liabilities, your employment status depends on a number of factors.
You will be classed as a sole trader if you are running your business for yourself and taking all the responsibility and decision-making, such as price setting and providing the equipment to carry out the work, if you have multiple clients or customers at the same time and you are providing your products or services to make a profit.
It is also possible to be both an employee and self-employed at the same time, for example, if you are employed during the day but work for yourself during evenings or weekends.
Self-employment or set up a company?
One of the most important decisions you will have to make when starting to work for yourself is whether to act as a sole trader or to set up a company.
Self-employment can be more straightforward than setting up a company, but you still have to ensure you understand and meet your tax obligations.
Sole traders have responsibility for all decisions and aspects of running their own business, from invoicing and bookkeeping to filing tax returns. Business and personal finances are treated as the same, which can be easier from an administrative perspective, but also means any financial difficulties facing your business will also impact your personal finances.
Setting up a limited company will mean business and personal finances are separate as the company is a separate legal ‘entity’. Operating a limited company, however, brings considerably more administrative and reporting responsibilities.
In most cases, people will start out as sole traders, before moving on to set up a limited company once they are established with customers and set up to meet the admin requirements of running a limited company.
Registering as self-employed with HMRC
As a sole trader, you are required by law to register as self-employed with HMRC. This is best done as soon as you start working for yourself so that you can stay on top of your paperwork, and certainly no later than 5 October after the end of the tax year that you started being self-employed. If you do not register, you could be charged a penalty.
Once you register, you will be given a Unique Taxpayer Reference (UTR). This is a unique ten-digit number that you will need in any dealings with HMRC such as completing your Self Assessment tax return.
You will then receive a notice from HMRC to complete your tax return for the tax year you started your business.
If you have in the past been previously registered as a sole trader, you will be reissued your old UTR when you re-register.
Note that some business sectors have special tax rules and require additional registration, such as the Construction Industry Scheme (CIS).
If your trading income is below £1,000 and are eligible and want to claim the trading allowance, it will not be necessary to register your self-employed income with HMRC.
As a sole trader, you will be liable for taxes, including income tax and National Insurance contributions, based on the profits from your business. This is regardless of how much money you ‘draw’ from the business.
Profits are calculated over a 12 month accounting period. It will be important to have processes in place to keep accounting records so that you can complete your tax return.
Tax is payable at the end of July each year, based on the profits in your previous tax return, and a balancing payment is made the following January taking account of how your profits have changed from the previous year.
Self-employed individuals must also pay Class 2 National Insurance. This is charged at a flat rate. Class 4 contributions are based on profits.
These are collected in the same way as payments for income tax.
You may also be liable for additional taxes, depending on your circumstances. If you employ people, you will need to operate PAYE and pay employer National Insurance contributions, pensions.
You may also need to pay VAT or business rates.
Accounting & record keeping
One of your responsibilities to HMRC is to keep records of business income and of expenses in order to prepare an accurate Self Assessment tax return.
You need to prepare accounts so you can work out what profits or losses you have made from your self-employment. HMRC use this information to calculate what income tax and National Insurance contributions are due from your self-employed earnings.
There is no standard format as to what accounting records a business will need to keep, as it will vary depending on the size and nature of the business.
Self-employed tax planning
As well as understanding your tax liabilities, you should also take time to understand if there are ways to bring down your tax bill, by making full use of expense, and any tax reliefs or schemes that you may be eligible for.
You can claim businesses expenses against profits, provided the expenditure relates to business use. You may also be able to claim for certain expenses if you work from home.
If you set up a limited company, the company pays corporation tax on profits, while you would take salary and dividends from the company as your personal income.
Taking professional advice can help you understand which would be a more tax-efficient or suitable option for your circumstances.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert tax, financial, legal or other advice should be sought.