Thinking of going self-employed? Expert tax tips

Becoming self employed is a new and exciting chapter of life, but it does come with extra responsibilities. With so much to think about, we asked David Genders, author of The Daily Telegraph Tax Guide to explain the key financial and tax points you need to consider when going self-employed.

By becoming self-employed you will have control over:

  • Your working hours giving you the opportunity to fit work around family life;
  • How your work is done; and
  • Most importantly, the earning potential of your business.

With so much going on, it is very easy to miss some of the crucial elements of starting your own business – in particular relating to the financials. So, I have pulled together some practical guidance to help you get things right.

First things first – Am I self-employed?

In most cases it will be obvious if you are self-employed. Sometimes, however, it is difficult to distinguish between:

  • Employment (a contract for service); and
  • Self-employment (a contract for services).

Your business will have the trappings of self-employment if you:

  • Are responsible for the success or failure of the business;
  • Are paid a fixed fee, or price, for the work;
  • Can decide how, when and where the work should be done;
  • Can dictate the hours you work;
  • Provide your own tools; and
  • Significantly have no entitlement to paid holiday or sick leave.

If any of the above relate to you, then you need to consider yourself as self-employed once your business is up and running.

In order to do so legally, you must register with HMRC. You can find exactly what you need to do in, 5 Things you must do when you go self employed, and you can also take a look at the HMRC website.

Self-Employment Records and Accounts

From the moment you start working as self employed, I recommend you open a separate bank account for your business. The records to account for include:

  • Your sales and other receipts; and
  • Purchases and overhead expenses

Invoices, bank statements and all documentation supporting purchases made should be kept and filed in an orderly manner, either electronically or manually, to help make things as easy as possible for you.

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SELF EMPLOYED TAX TIPS

  • An obvious and convenient choice to draw up your business accounts is 31st March as it coincides with the end of the Tax Year on 5th
  • Sometimes, however, it is better to go with a date early on in the tax year, such as 30th April, as this gives you more time to plan for the payment of the tax due on your profit.
  • Alternatively, if your business is seasonal in nature, it may pay you to pick an accounting date to coincide with the slack time of the year and when stocks are low.

The statement of the profit or loss of your business is not usually the simple difference between receipts and payments.

Adjustments are required for unpaid sales and amounts due to your suppliers or for overhead expenses at your year end. When it comes to expenses make sure you claim all the overhead costs.

SELF EMPLOYED TAX TIPS

  • If you are married or live with a partner who helps in the business you can claim the salary paid to him/her as a business expense. You should pay a sensible amount for these services. If this is their only job or income there will be no tax or National Insurance to pay on an annual wage less than £8,840 (2021/22).
  • If you work from home and a specific area of your home is set aside as an office you can claim a deduction for the appropriate proportion of fixed costs such as mortgage interest, council tax, light and heat, cleaning, etc.
  • Where the costs of your business, such as a car, are used both for personal use and work you should charge a fair and reasonable percentage of the expenditure to the business.

Taxable Profits

The profits shown by your accounts may not be the same as that on which you pay Income Tax. This is because some expenditure is not allowable in working out the taxable profits of a business. These include:

  • Business entertainment;
  • Amounts spent on items of a capital nature;
  • Professional costs related to capital expenditure; and
  • Own wages or drawings.

SELF EMPLOYED TAX TIP

Any of the expenditure for your business which you incurred in the seven years before you started to trade is:

  • Treated as if it was spent on the first day of business; and
  • Tax deductible.

Equipment and motor cars

A 100% rate of allowance can be claimed on annual expenditure up to £1 million on most types of plant and machinery, equipment, furniture and fittings. The rate of allowance on expenditure on motor cars is much less generous though.

Capital Allowance thresholds change regularly, and the rules are complex so check the exact details with your accountant.

SELF EMPLOYED TAX TIP

It may be tax efficient to purchase items of a capital nature toward the end of an accounting year rather than at the start of the following year. You will then benefit from the 100% first year allowance at an earlier date.

Financial losses through your new business

It is almost certain that your business will go through both good and bad times. Generally, losses can be set against other income or capital gains of the same tax year.

Any unrelieved loss then has to be carried forward for offset against profits of the same business in future years.

SELF EMPLOYED TAX TIP
There is a special form of tax relief for trading losses in the early years of a new business.
Losses incurred during the first four tax years can be set against your total income for the three years prior to that in which the loss arises. Relief is first of all given against total income for the earliest year.

Income Tax and National Insurance

In working out the amount of income tax due on your business profits you can deduct the personal allowance, £12,570 for 2021/22.

The basic rate (20%) applies to income between £12,571 and £50,270.

The higher rate (40%) applies to income between £50,271 and £150,000.

The additional rate (45%) applies to income over £150,000.

Please note that the personal allowance is eroded by £1 for every £2 you earn over £100,000. This means that the entire allowance disappears if you earn over £125,140!

SELF EMPLOYED TAX TIP

As a self-employed taxpayer you can set up a personal pension to save for your old age. You can make:

  • Regular contributions or ad hoc payments.

The maximum amount you can contribute on which you will get tax relief at your top rate of tax is equivalent to:

  • Your annual business profits, but subject to a maximum of £40,000.

National Insurance Contributions for self employed

In addition to Income Tax, sole traders usually pay two types of National Insurance Contributions (NICs), namely:

  • Class 2 NI at £3.05 per week for the 2021/22 tax year. You only need to pay Class 2 NI if your annual profits are above £6,515.
  • Class 4 NI at 9% on profits between £9,568 and £50,270, reducing to 2% on profits over £50,270 for the 2021/21 tax year.

You will find a more detailed explanation of taxes and NICs for self employed workers in;

Other factors to bear in mind

Self-employed individuals cannot claim some of the state benefits such as the contribution based Jobseekers Allowance, Statutory Sick, Maternity and Paternity pay.

As your business progresses and becomes more profitable you should think about transferring it to a Limited Company.

And finally

Always look to the future and plan for your retirement whether you are contemplating a sale or handing the business down to the next generation.

This guide has been written exclusively for ByteStart by David Genders, author of The Daily Telegraph Tax Guide since 1982. Having been a Partner in the firm, he is now a Consultant to Sayers Butterworth LLP, a firm of Chartered Accountants specializing in personal tax issues.

Last updated: 19th April, 2021

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