Guide to Tax and National Insurance when you're Self-Employed

If you’re going self-employed you’re effectively setting up a new business and starting on a new adventure.  Once you have decided what you’re going to do, you’ll need to decide on what the structure of your business is going to be, whether you’re a sole trader or a limited company.  Crucially too, you also need to be aware of what taxes you need to pay when going self-employed.  This article will help you understand what taxes and national insurance you need to pay when starting your self-employed journey. The downside of doing things incorrectly is a self-assessment investigation which no one wants!

Checklist for starting up as a sole trader

• Register as a sole trader with HMRC through the Government website. This ensures they are aware you need to pay tax through Self-Assessment and pay Class 2 and 4 National Insurance contributions.  You will need to register with HMRC by 5^th October after the end of the tax year during which you became self-employed.
• Set up a business bank account.
• Record your profits and evidence of your business expenses. It’s best to establish a robust process early on for this to help you complete your HMRC tax return.
• Check whether you need insurance.
• If you’re working from home, you need to notify your mortgage lender

You may also wish to consider setting up as a Limited Company.  There are certain things you will need to do, including registering your company with Companies house and putting together a memorandum of association.  You will also need to pay Corporation Tax

What types of tax do you pay when you’re self-employed?

There are three types of taxes that you’ll need to consider:

• Income Tax
• Class 2 National Insurance
• Class 3 National Insurance

You also need to consider the tax-free personal allowance, essentially how much you can earn before you start paying tax.

What is my tax-free allowance when I’m self-employed?

You’re allowed to earn a certain amount tax-free each tax year.  The tax year in the UK runs from 6 April to 5 April every year.

The personal allowance for 2018/2019 was £11,850 which increased to £12,500 for tax year 2019/2020.  This is the same for employed and self-employed people.

Your personal allowance is restricted once you earn more than £100,000.  Once you hit this amount, your personal allowance works on £1 for every £2 you earn.  If you earn over £122,000 you are not eligible for any personal allowance.

What if I have 2 jobs?

You will only get one personal allowance which HMRC will usually apply to the job which pays you the most.  Your main job should have the tax code 1250L or 1185L.  Your secondary job will have the tax code BR, D0 or D1.

How much tax do you pay when you’re self-employed?

You pay tax based on your business profits.  This is dependant on how much income you have generated, offset against the ‘allowable expenses’ you’ve incurred to run your business.  Business costs should also be deducted from your income so you can calculate your profit.

For 2019/2020 you can make up to £12,500 tax-free (2018/2019 – £11,850).  For earnings up to £50,000 you will pay the basic tax rate of income tax of 20% (compared to £46,350 for 208/2019).  The higher tax rate of 40% is triggered once you earn £50,000.  The highest bracket is earnings over £150,000 where you will pay the highest tax rate of 45%.

It’s important to note the rate is only applied to the profit between the brackets, and not the whole amount.  So assuming your profit is £75,000 in the tax year 2019/2020 your tax will be as follows:

• No tax on the first £12,500
• 20% tax on £37,500 (difference between £12,500 and £50,000) = £7,500
• 40% tax on £24,999 (difference between £50,001 and £75,000) = £9,999.60

Total = £17,499.60

If you earn less than £1,000 the Tax-Free Trading Allowance on Property and Trading Income applies.  This means you can get up to £1,000 per year tax-free.

How much National Insurance do you pay when you’re self-employed?

Class 2 National Insurance Contributions

Most self-employed people pay Class 2 NICs if your profits are at least £6,365 during the 2019/2020 tax year (£6,205 for 2018/2019).  If you’re over the limit you will pay £3 a week, or £156 a year for the 2019/2020 tax year (£2.95 a week or £153.40 a year for tax year 2018/2019).

Class 4 National Insurance Contributions

If your profits are over £8,632 or more in 2019/2020 you will also pay Class 4 NICs.  You will pay 9% on profits between £8,632 and £50,000, and 2% on anything above this (for tax year the range is £8,424 to £46,350)

Example – If you make a profit of £75,000 you will pay (based on 2019/2020 tax year):

Class 2 NICs

• £3.00 per week / £156 for the 2019/2020 tax year (£2.95 / £153.40 for 2018/2019)

Class 4 NICs

• 9% on profits between £8,632 and £50,000 = £3,327.12
• 2% on profits between £50,001 and £75,000 = £499.98
• Total = £3,827.10

Total payable = £3,983.10

How to pay National Insurance and Tax when you’re self-employed?

You will have to submit a Self-Assessment tax return for the previous year.

• For 2018/2019 you will need to submit your paper return by 31^st October 2019 and online return by 31^st January 2020
• For 2019/21020 you will need to submit your paper return by 31^st October 2020 and online return by 31^st January 2021

What can I claim for as a self-employed?

Self-employed allowable expenses

Your business will have ongoing running costs you can deduct to calculate your taxable profit.  These include: –

• Training courses related to your business
• Travel costs i.e. fuel, parking, train fares
• Office and stationery costs
• Things you buy to sell on i.e. stock
• Clothing expenses i.e. uniforms
• Advertising or marketing costs
• Staff costs
• Financial costs i.e. bank charges
• Costs of your business premise i.e. business rates, utility bills
• If you work from home you may be able to claim a ‘proportion’ of your costs for things like heating, electricity, council tax, mortgage interest/rent, internet and telephone use.
• If you use something for both business and personal you can only claim allowable expenses for the business cost.  For example, if your phone bill was £100 and half of these were business calls, you can claim £50.

Other Self-Employed Benefits

• If you’re self-employed and not earning much money, you may be entitled for income support, universal credit or housing benefit. You can check the government website for more details
• You may be eligible to get a New Enterprise Allowance grant from the government

So in summary, becoming self-employed is an exciting journey to venture on.  The very nature of being self-employed means you do need to take ownership of all of your affairs, including how you pat tax and national insurance.  If you do need any Tax Advice, don’t hesitate to call us on 0800 471 4546.