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Guide To Self Employment

Becoming Self Employed

Definition of Self Employed

Being self-employed is the simplest form of running your own business. You don’t have to set up a company and there is very little paper work to do. You can do self employed work at the same time as being employed or receiving other income.

You are personally responsible for the income and any losses or liabilities you incur. This is what makes it different from setting up a company.

HMRC have an online tool to help determine if you are self employed. But if you are selling goods or services for a profit, rather than just selling unwanted items occasionally, and you are responsible for delivering these yourself, you are probably self employed.

You don’t need to have a separate bank account for your self employed work although many people do. If you use a personal bank account and HMRC decide to investigate your business they may ask to see it. It’s easy to set a separate account up: typically you would have an account in your name eg Joanne Smith but trading as eg Joanne Smith Associates.

There are very few difficulties in working out how to be self employed. You do not need to register a trading name but you can if you wish to so as to protect it.

Self employed people are often referred to as sole traders although they don’t have to mean the same thing. A self employed person can be in partnership with someone else and an individual can trade on his or her own through a company. But if you have questions about sole trader tax and accounts, or you need a sole trader tax calculator, the information in this guide should help you.

Registering as Self Employed

You’ll have to tell HMRC that you are self employed although this is straightforward. You don’t have to register as soon as you start self employment – you have until the 5th October in the second year of trading – but it’s a good idea to do this as early as possible.

Once you’re registered, you’ll have to keep adequate records of your sales (turnover) and any outgoings associated with your self employment. See Turnover and Expenses below


Self Assessment

As a self employed person you’ll pay income tax in the same way and at the same rates as you would for income for employment. You’ll have to complete a self assessment tax return and you will declare your self employed income separately on your return.

You will complete your self employment tax return for the period up to April 5th and pay tax on your self employed income up to that date. You can choose a different accounting period but you still pay tax for the 12 month period up to April 5th so for most people it is easier to use this as your accounting date (box 7 of the self employment pages of the short self assessment return). If you choose a different accounting period you will have to submit a full self assessment return.

You’ll also pay national insurance as part of your self assessment but the rates are different from someone who is an employee.

Deadlines and payments on account

You’ll have to submit your self assessment tax return by January 31st for the year up to the previous April 5th. This is also the deadline for paying any tax and national insurance due for the previous tax year. You’ll have to arrange the payment yourself; it doesn’t happen automatically.

Unless the tax you owe is less than £1000 you’ll also have to pay tax on account for the subsequent tax year ie the 12 months beginning April 6th before the January 31st tax return deadline. This payment will be in two stages: half on January 31st and half on July 31st. Remember that by January 31st you’ll be 10 months into the tax year so you should already have set aside money for your tax liabilities; you can use the Triginta self employment tax and NI calculator to make sure you’re setting aside the right amounts of tax and national insurance.

HMRC will tell you what you payments on account you need to make when your return is submitted but, again, this payment doesn’t happen automatically so you’ll have to set it up.

You can ask for your payments on account to be reduced if you think your income will be lower this year than in the previous year.

What dates should I use to account for income and expenses?

For most self employed people the best way to declare income and expenses is by using the ‘cash basis’.

The cash basis means that you only pay tax on income when you receive it and you can claim for expenses when you actually pay them. At the end of the tax year, you don’t have to declare income you haven’t received before the end of the year, even if the work was done and invoiced at an earlier date.

The system is simpler to manage than the alternative accural basis accounting methods and probably helps you by ensuring that you don’t pay tax on income you haven’t yet received. But it is only available for businesses with a turnover of £150,000 or less and doesn’t apply to all types of business. You may need to take professional advice if you’re not sure.

To use the cash basis accounting scheme just tick the cash basis box (box 8) on the self employment pages of your tax return.

Making Tax Digital for the self employed

The government has an objective of changing the way all individuals and businesses submit their tax returns. This will not affect self assessment income tax returns for self employed people until 2021 at the earliest, and it is still not certain what changes if any will be made. But it is nevertheless worth being aware of the proposals to ensure you are prepared.

The roll out of MTD has been significantly delayed and, as things stand, the only businesses that are directly mandated are VAT-registered businesses (including sole traders registered for VAT) and then only for their VAT returns from April 2019.

The government announced in 2019 that MTD will not be mandated for other taxes, including income tax for the self employed, until at least 2021.

It is in any case not clear what if any changes would be made if and when MTD is rolled out further. The proposals on which the government initially consulted included quarterly submission of data, but not more frequent tax returns. Nearly 93% of people already submit their self assessment returns online and 99% of quarterly VAT returns are submitted online.

Triginta will be prepared for MTD if and when it is rolled out further and will ensure it is compliant with software requirements. But in view of the uncertainty surrounding the roll out we do not believe it is worth it for individual self employed people to make any changes or preparations.

What kind of records do I need to submit in my self assessment return?

If you are below the threshold for VAT, you can submit a short self assessment return to HMRC. This means that you can just record your income (turnover) and your total allowable expenses, rather than having to break your business costs down into different categories.

You do not need to submit all your business records with your self assessment return, but you must keep records of income and expenses including

  • Receipts for goods and stock
  • Bank statements and cheque book stubs
  • Sales invoices

You must retain these records for five years after the January 31st submission deadline of the relevant tax year, so for example your records for the 2017-18 tax year must be kept until at least the end of January 2024.


Income Tax And National Insurance

You pay the same income tax on self employed income as you do on income from employment. You have the same tax allowances, tax bands and tax rates as someone in employment.

As a self employed person, you pay income tax on your profit: the difference between your turnover (the payments you receive from customers) and your business costs (allowable expenses).

Even if you not draw on the profits you have made – for example if you leave it in the bank account – you still pay tax on it.

What happens if I’m employed and self employed at the same time?

You can be employed and self employed at the same time. For example you might work one or two days a week for an employer and on other days have your own clients.

Your income from employment and self employment will be combined to work out your tax and national insurance. You have a single tax allowance and the tax bands will be spread across your employment and self employment income. You pay the same rate of tax on both forms of employment, but the national insurance rates are different.

You’ll declare both your employment and your self employment on your self assessment return. There are separate pages for each employer and to declare your self employment turnover and expenses.

You’ll pay tax on your employment income via PAYE and this will be collected by your employer regularly through the year. Your self employed profit will be added to this when you complete your self assessment return to work out your total tax and national insurance liability at the end of the year.Your self employment income tax will be added to this when you complete your self assessment return to work out your total tax and national insurance liability at the end of the year.

The Triginta tax calculator will take account of your employment income to work how much extra you need to set aside to cover your self employed earnings.

Self employed tax rates

The 2020-21 tax rates and allowances are shown in the table below. If you pay income tax in Scotland the rates are different

The Triginta self employment income tax calculator works out the amount of tax you have built up at any point in the year taking account of changes in your turnover and expenses and how much of your allowances and self employed tax brackets you have used.

You receive a personal allowance which is free of income tax. The standard allowance for 2020-21 is £12,500 but this could be higher if you are married or in a civil partnership and your partner has transferred part of their personal allowance to you. The tables below are based on the standard allowance.

UK Excluding Scotland
Up to £12,500* Nil
£12,500 to £50,000 20%
£50,000 to £150,000 40%
Over £150,000 45%
*When your income goes above £100,000 the personal allowance is withdrawn
at a rate of 50%. This means that your effective rate of tax on income between
£100,000 and £123,700 is 60%.

Scotland
Up to £12,500* Nil
£12,500 to £14,585 19%
£14,585 to £25,158 20%
£25,158 to £43,430 21%
£43,430 to £150,000 41%
Over £150,000 46%
*When your income goes above £100,000 the personal allowance is withdrawn
at a rate of 50%. This means that your effective rate of tax on income between
£100,000 and £123,700 is 60%.


National Insurance for self employed people

Self employed people pay class 2 and class 4 National Insurance Contributions (NICs).

Class 2 National Insurance is a fixed rate of £3.05 per week in 2020-21 as long as your profits are above £6,475.

Class 4 National Insurance is

  • 9% of your profits between £9,500 and £50,000 and
  • 2% of profits above £50,000

The Triginta tax self employed national insurance calculator works out how much Class 2 and Class 4 NICs you have built up at any point in the year, taking account of changes in your turnover and expenses and how much of your allowances and bands you have used.

The government initially proposed that class 2 self employed NI contributions would be abolished but this proposal was withdrawn in Budget 2018.

You don’t pay self employed NICs after you have reached the state pension age.


Turnover and Expenses

What is my self employed turn over

Your turnover is the total of the payments you receive from your customers over a time period, before you deduct the cost of goods or materials that you have bought and any allowable expenses.

If your turnover is below £150,000 a year you’ll probably be able to use the ‘cash basis’ rather than traditional accrual-based accounting, which means that you only have to declare income when it is actually received. You don’t have to account for it at the date it was invoiced and you don’t have to declare the income if the invoice is not paid. There are some categories of business that can’t use the cash basis so check with HMRC, but for most people it’s the best option. All you have to do is tick the box (box 8 on the short self assessment form) to say you’re using the cash basis.

What expenses can I claim when I’m self employed?

You can deduct the costs associated with running your business from your turnover to calculate the profit on which you pay tax.

You can deduct the costs of goods that you have bought to resell or to use in the business, as well as allowable expenses including

  • travel
  • business accommodation
  • office and equipment costs
  • employees or subcontractors
  • advertising and marketing
  • professional fees
  • financial charges

You can only claim for expenses that relate to the running of your business. If you use something for both personal use and your business, you can only claim for the portion of the cost that is business related. You’ll have to find a reasonable method of dividing your costs and keep a record of both personal and business use.

There are certain things you can’t claim self employment tax deductions for, even though they’re costs incurred by your business. The one that people often find surprising is client entertainment. You can’t claim the amount you’ve spent on a client but you probably will be able to claim the costs of your own meals and drink as subsistence if you are away from home.

HMRC give guidance about what you can claim including a self employed allowable expenses list and if you’re not sure you should seek professional advice from an accountant or lawyer.

If you’re using the cash basis for your self assessment, you only have to claim the expenses you’ve actually paid. Money you owe is not counted until you pay it.

Triginta calculates your expenses to work out how much profit you’ll be paying tax on throughout the year. The self employed expenses calculator is here.

If your expenses are below £1000 you can claim a £1000 allowance, known as a trading allowance, rather than your actual expenses when you submit your return.

Simplified expenses if you’re self employed

You can use simplified expenses to work out your self employed business expenses on your self assessment return. These use flat rates for certain categories of expenditure rather than the actual costs you have incurred to make the calculations easier. Simplified expenses can be used for

  • Vehicles including milage allowances
  • Working from home
  • Living in your business premises

All other costs have to be calculated using the actual costs you incur. You don’t have to use simplified expenses if it’s more advantageous to claim the actual costs.

Can I claim for expenses before I start trading?

You can claim self employed tax allowance for the expenses you incur for up to seven years before you start trading and receiving income. If the expenses would have been allowable against tax if you had incurred them while trading, you can claim for them when you start trading as pre-trading expenses. Just include them as an expense on you first day of trading.

Different rules apply to the VAT on expenses if you are VAT-registered.

What can I claim for capital assets?

You can claim allowances against tax for items that you keep to use in your business such as equipment.

In most cases you can deduct the full cost of such items from your profits in the year you purchase them, as long as the total costs are within your annual investment allowance (AIA). The maximum amount of the AIA has been raised to £1 million from January 2019.

There are certain items you can’t use your AIA for, including cars.


Pension


Can I pay into a pension when I’m self employed?

You should think about setting money aside for your retirement when you’re self employed.

When you pay into a private self employed pension plan you will receive tax relief in full against the contributions as long as they are not more than 100% of your earnings and don’t exceed £40,000 a year.

If your rate of income tax is the basic rate of 20% your pension provider will claim this relief for you and add it to your pension pot. This is known as relief at source.

This means that for every £80 you contribute, your pension provider will add £20 as tax relief and the total payment into your pension will be £100.

If your rate of tax is above the basic rate you can claim additional relief on top of the relief at source: 20% if you pay tax at the 40% rate and 25% if you pay tax at 45%. You claim this on your self assessment return at the end of the year.

The simplest type of private pension for a self employed person is a stakeholder pension. All of the big pension and insurance companies provide them, as well as banks and building societies. They have to abide by certain conditions laid down by government to limit the charges you have to pay and to ensure they are flexible to access.

You can change or stop your contributions in the future if your circumstances change or you stop working.

You can also take a stakeholder pension with you in the future so even if you are working for an employer you can continue contributing to it yourself and ask your employer to make contributions too.

Because there’s a wide range of providers offering stakeholder pensions, you’ll be able to research the best pension for a self employed person.

The Triginta tax calculator takes account of your pension contributions and deducts the additional relief from the amount you need to set aside for tax.


VAT

Do I need to register for VAT when I’m self employed?

You must register for VAT (Value Added Tax) if your VAT taxable turnover (not your profit) is over £85,000 over a 12 month period. This is a rolling 12 month period rather than a fixed period like a tax year or calendar year. So if your turnover goes over £85,000 in any 12 month period, or you know that it will, you must register for VAT.

Your self employed VAT taxable turnover is all of your turnover that is not exempt from VAT.

Being registered for VAT means that you are responsible for charging your customers VAT, which you collect on behalf of HMRC. The standard rate of VAT is 20%. You also recover the VAT that you have paid on your business purchases and expenses (input tax) which you deduct from the VAT you have charged your customers before paying the balance to HMRC.

VAT Flate Rate Scheme

As long as your turnover is less than £150,000 you can opt to join the VAT Flat Rate Scheme. This means that, instead of deducting the VAT on your purchases from the VAT you have collected from your customers, and then paying the difference to HMRC, you pay a fixed rate to HMRC according to the type of business you run. The principal advantage of the scheme is that it is easier to administer, and you also benefit from an additional 1% reduction of the fixed rate for your first year. The disadvantage is that you can’t reclaim VAT on your purchases except for certain capital assets over £2,000

The scheme used to be particularly attractive for those with low business costs, for whom the fixed rate they paid to HMRC left them better off than if they were to just reclaim the VAT on their actual purchases. But these low cost businesses – those whose costs are less than 2% of their turnover or £1,000 a year, whichever is greater - now pay a higher fixed rate which means that for most people this advantage has been removed. It is worth looking at whether the flat rate scheme is the best solution in your circumstances.

Voluntary registration for VAT

You can also register for VAT voluntarily if you’re below the threshold. This may be advantageous if you have a lot of business costs to recover, but you’ll have to charge your customers VAT as well. If your customers are businesses or large organisations this may not be a problem as they will probably be registered for VAT themselves so can recover the VAT you charge them. But if you are selling goods or services to customers who are not VAT registered, they may be put off by the additional VAT charge. So you should think carefully about the circumstances of your business and work out which option is best for you.

Accounting for VAT when you’re self employed

When you register for VAT you’ll be given a VAT number and you should charge VAT from that point.

You’ll have to keep adequate records including copies of the invoices you give to your customers and the VAT you have paid on your purchase and expenses. Records must be kept for at least 6 years.

You must issue invoices in a valid form, though for retail supplies under the value of £250 this can be in a simplified form.

As long as your turnover is £1.35 million or less, and your VAT arrangements are in good order, you’ll probably be able to use the cash accounting scheme, which means that you only account for VAT that you have charged your customers when you are paid and you only claim VAT on your inputs when you pay your supplier. This is simpler to administer and could help your finances because you only pay VAT to HMRC when you have been paid.

VAT returns are usually submitted quarterly and this can be done online. You can opt to submit annual returns, subject to certain conditions, in which case you’ll have to make quarterly or monthly instalments calculated by HMRC.

Can I claim for VAT before registering?

You can claim for VAT that you pay on purchases before registering for VAT, as long as they relate to the VAT taxable goods or services that you supply and as long as they haven’t been used up before you register.

The time limits are:

  • 4 years before registration for goods
  • 6 months for services

Making Tax Digital for VAT

From April 1st 2019, businesses including self employed people with a turnover above the VAT threshold (currently £85,000) have been required to submit digital returns for VAT.

Making Tax Digital (MTD) does not require you to keep additional records for VAT, just to record and submit them digitally.

If you use MTD you will need MTD-compatible software to keep digital records and exchange data with HMRC. This can be in different formats including conventional spreadsheets but if it is not capable of exchanging data directly with HMRC it will need to be used in conjunction with bridging software.