Tax when you’re self-employed usually refers to the tax payment of sole traders. After initially registering with HMRC as self-employed via the form CWF1, sole traders are expected to figure out how to calculate their tax and national insurance themselves.
It’s a massive change, going from not having to deal with your own tax payments as an employee to being solely in charge of your accounts. So, to help you understand, this guide covers everything you need to know about Income Tax and National Insurance contributions for a self-employed individual.
REGISTERING AS SELF-EMPLOYED
First of all, you need to register as self-employed with HMRC. This can be done by visiting HMRC’s sign-up page or you can call their helpline on 0300 200 3310 if you need further support.
We offer the sign-up process as part of our engagement fees and this could save you some considerable time and effort.
Is your income less than £1,000 during the tax year? If so, you won’t have to register this year, as there is a trading allowance available to those who have small side businesses or hobbies and earn less than this amount overall.
Only once your income exceeds £1,000 will you have to register for self-assessment.
It’s important that you register as self-employed, as you must register by 5th October following the end of the tax year in which you started your business.
Even before you register as self-employed, your duties start as you’ll need to keep business records straight from your first day. Another responsibility of yours will be to complete and submit a Self Assessment tax return every year – as well as paying your Income Tax, Class 2 and possibly Class 4 National Insurance, depending on how much profit you make.
WHAT CAN YOU EARN BEFORE YOU START PAYING TAX?
If during the tax year, your only income is from self-employment and your profits are less than the £12,570 Personal Allowance (during 2021/22), then you will not pay any Income Tax. You may, however, need to pay National Insurance as the thresholds for paying these taxes are less.
If you have other income during the tax year, this may have used some of your personal allowance already and therefore you will need to include this when doing your calculations for the tax year.
Other income includes:
- Wages
- Profit from self-employment
- Pensions
- Rental income
- Trust income
- Interest on savings
- Income from dividends
There’s no need for you to worry about all this. Just make sure that you send us all your different sources of income and we will ensure your tax return is submitted to HMRC in it’s most tax efficient form.
HOW MUCH TAX DO YOU OWE?
Sole traders only pay Income Tax on profits – not total income. This means you deduct your allowable expenses from your total income to work out your taxable income or ‘profit’.
This ‘profit’ is what you will then pay Income Tax on, provided that it exceeds the £12,570 Personal Allowance.
As of 2021/22, Income Tax bands above £12,570 are as follows:
Income Tax band Taxable income Rate of tax
Basic rate £12,571-£50,270 20%
Higher rate £50,271-£150,000 40%
Additional rate Over £150,000 45%
These bands are different in Scotland. If this affects you, please find out more here.
The rate of tax isn’t applied to the entire sum, only the profit you make between the brackets. So, if you earned £20,000, you would pay 20% tax on the £7,430 in excess of the personal allowance. Once you’ve figured out your taxable income, the next step is to determine the amount due to National Insurance contributions.
DO YOU NEED TO MAKE NATIONAL INSURANCE CONTRIBUTIONS?
National Insurance contributions go towards state benefits, whether that’s your pension or welfare support like Universal Credit.
Where employees have such contributions (Class 1) taken directly out of their earned income, the majority of self-employed people pay National Insurance contributions (Class 2) once they’re making at least £6,515 in profit. Once over this amount, they will pay £3.05 weekly.
If you’re self-employed and are making profits of £9,568 or higher, you’ll pay 9% on profits between £9,568 and £50,270, and 2% on anything above (Class 4).
HOW DO YOU PAY YOUR TAX LIABILITY?
Once you have collected all your information, all that’s left to do is file your Self Assessment tax return.
If you’re choosing to do this via a paper submission, you’ll need to complete your Self Assessment tax return by 31st October. If you file before the 31st October, HMRC will send you a tax calculation and detail what tax needs to be paid and by when.
However, should you prefer a few more months to organise your affairs, electronic submissions are due on 31st January. It is worth noting that the deadline for both filing your online tax return and paying any taxes due is the 31st January.
As we use electronic software here at Everyday Accountants, you get that ‘extension’ to the paper filing deadline, although we do encourage our clients to get their information in as soon as possible to avoid those last minute surprises.
WHAT ABOUT CORPORATION TAX?
As you’re a sole trader, your income is assessed within the Income Tax and National Insurance (Class 2 and 4) system. However, if your profits exceed £40,000 we recommend you should get in touch to consider the possibilities of incorporating and reaping the rewards of the additional tax planning opportunities that arise.
Information accurate at time of writing