Navigating Your First Year as Self-Employed in the UK: When and How to Pay Taxes
Becoming self-employed is an exciting journey filled with opportunities for personal and professional growth. However, it also comes with a set of responsibilities, particularly when it comes to taxes. If you’re in your first year of self-employment in the UK, understanding when and how to pay taxes is crucial to avoid penalties and ensure compliance with HM Revenue and Customs (HMRC). This comprehensive guide will walk you through everything you need to know about paying taxes in your first year as a self-employed individual in the UK.
Understanding Self-Employment in the UK
Before diving into the specifics of tax payments, it’s essential to understand what it means to be self-employed in the UK. Self-employment refers to working for yourself rather than for an employer. This could mean running your own business, freelancing, or working as a contractor. As a self-employed individual, you are responsible for managing your own taxes, National Insurance contributions, and other financial obligations.
Registering as Self-Employed
The first step in your self-employment journey is to register with HMRC. You must do this as soon as possible after starting your business. The deadline for registering is by October 5th following the end of the tax year in which you became self-employed. For example, if you started your business in June 2023, you must register by October 5th, 2024.
You can register online through the HMRC website. Once registered, you will receive a Unique Taxpayer Reference (UTR) number, which you will use for all communications with HMRC.
Understanding the UK Tax Year
The UK tax year runs from April 6th to April 5th of the following year. This is important to know because your tax obligations are based on this period. For example, the 2023/24 tax year runs from April 6th, 2023, to April 5th, 2024.
When to Pay Taxes as a Self-Employed Individual
As a self-employed individual, you will need to pay two main types of taxes: Income Tax and National Insurance contributions. The timing and process for paying these taxes depend on your earnings and how you choose to manage your tax affairs.
Income Tax
Income Tax is a tax on your earnings. The amount you pay depends on your taxable income, which is your total income minus any allowable expenses and tax reliefs.
In your first year of self-employment, you may not need to pay Income Tax immediately. Instead, you will pay it in arrears through the Self Assessment system. Here’s how it works:
- First Tax Year: In your first year of self-employment, you will need to complete a Self Assessment tax return for the tax year in which you started your business. This return will calculate the Income Tax you owe based on your earnings from self-employment.
- Payment on Account: If your tax bill is more than £1,000, you may need to make payments on account. These are advance payments towards your next tax bill. Payments on account are due in two instalments: January 31st and July 31st.
- Balancing Payment: Any remaining tax owed after your payments on account will be due by January 31st following the end of the tax year.
For example, if you started your business in June 2023, your first tax year would be the 2023/24 tax year. You would need to complete a Self Assessment tax return by January 31st, 2025, and pay any tax owed by that date. If your tax bill is over £1,000, you would also need to make payments on account by January 31st and July 31st, 2025.
National Insurance Contributions
As a self-employed individual, you are also required to pay National Insurance contributions. There are two types of National Insurance contributions for the self-employed:
- Class 2 National Insurance: This is a flat-rate contribution of £3.45 per week (for the 2023/24 tax year) if your profits are £12,570 or more per year. If your profits are below this threshold, you can choose to pay Class 2 contributions voluntarily to maintain your National Insurance record.
- Class 4 National Insurance: This is a percentage of your profits. For the 2023/24 tax year, you pay 9% on profits between £12,570 and £50,270, and 2% on profits over £50,270.
National Insurance contributions are paid through the Self Assessment system, along with your Income Tax. The deadlines for paying National Insurance are the same as for Income Tax: January 31st for the balancing payment and July 31st for the second payment on account.
Keeping Records
One of the most important aspects of managing your taxes as a self-employed individual is keeping accurate records. HMRC requires you to keep records of all your business income and expenses for at least five years after the January 31st deadline for the relevant tax year.
What Records to Keep
- Income: Keep records of all your sales, invoices, and any other income you receive. This includes cash payments, bank transfers, and payments through platforms like PayPal.
- Expenses: Keep receipts, invoices, and bank statements for all business expenses. This includes costs like office supplies, travel, and equipment.
- Bank Statements: Keep copies of your business bank statements, as well as any personal bank statements that include business transactions.
- Mileage: If you use your car for business purposes, keep a log of your business mileage.
- Capital Allowances: If you purchase equipment or machinery for your business, keep records of these purchases as you may be able to claim capital allowances.
Using Accounting Software
Many self-employed individuals find it helpful to use accounting software to manage their records. Software like QuickBooks, Xero, or FreeAgent can help you track your income and expenses, generate invoices, and even submit your Self Assessment tax return directly to HMRC.
Completing Your Self Assessment Tax Return
The Self Assessment tax return is the form you use to report your income and expenses to HMRC. It is also used to calculate the amount of tax and National Insurance you owe.
Deadlines
- Online Tax Return: The deadline for submitting your online Self Assessment tax return is January 31st following the end of the tax year. For example, for the 2023/24 tax year, the deadline is January 31st, 2025.
- Paper Tax Return: The deadline for submitting a paper tax return is October 31st following the end of the tax year. For the 2023/24 tax year, the deadline is October 31st, 2024.
How to Complete Your Tax Return
- Gather Your Information: Before you start, gather all the information you need, including your income, expenses, and any other relevant financial information.
- Log in to HMRC Online Services: If you haven’t already, you will need to create an account with HMRC Online Services. Once logged in, you can access the Self Assessment tax return.
- Fill in the Relevant Sections: The tax return is divided into different sections, depending on your circumstances. As a self-employed individual, you will need to fill in the sections related to self-employment income and expenses.
- Calculate Your Tax: The tax return will automatically calculate the amount of tax and National Insurance you owe based on the information you provide.
- Submit Your Return: Once you have completed all the relevant sections, you can submit your tax return online. You will receive a confirmation from HMRC once your return has been successfully submitted.
Making Tax Payments
Once you have submitted your Self Assessment tax return, you will need to pay any tax and National Insurance you owe. The deadlines for making these payments are:
- January 31st: This is the deadline for paying any tax owed for the previous tax year, as well as the first payment on account for the current tax year.
- July 31st: This is the deadline for the second payment on account for the current tax year.
How to Pay
There are several ways to pay your tax bill:
- Online Banking: You can pay your tax bill using online or telephone banking. You will need your UTR number and the HMRC bank account details.
- Direct Debit: You can set up a direct debit with HMRC to pay your tax bill. This can be done through your HMRC Online Services account.
- Debit or Credit Card: You can pay your tax bill using a debit or credit card through the HMRC website. Note that there is a fee for paying by credit card.
- Cheque: You can send a cheque to HMRC, made payable to “HM Revenue and Customs only” followed by your UTR number.
- Bank or Building Society: You can pay your tax bill at your bank or building society using a paying-in slip from HMRC.
Understanding Payments on Account
Payments on account are advance payments towards your next tax bill. They are required if your tax bill is more than £1,000 and are due in two instalments: January 31st and July 31st.
Each payment on account is usually 50% of your previous year’s tax bill. For example, if your tax bill for the 2023/24 tax year is £2,000, you would make two payments on account of £1,000 each: one by January 31st, 2025, and the other by July 31st, 2025.
If your tax bill for the following year is higher or lower than the previous year, you will need to make a balancing payment or receive a refund when you submit your next tax return.
Claiming Tax Relief and Allowances
As a self-employed individual, you may be eligible for various tax reliefs and allowances that can reduce your tax bill. Some of the most common ones include:
Allowable Expenses
You can deduct allowable expenses from your income to reduce your taxable profit. Allowable expenses are costs that are incurred wholly and exclusively for your business. Some common allowable expenses include:
- Office Costs: This includes stationery, phone bills, and internet costs.
- Travel Costs: This includes fuel, parking, train or bus fares, and hotel stays if you need to travel for business.
- Clothing Expenses: This includes uniforms or protective clothing required for your work.
- Staff Costs: This includes salaries, wages, and benefits for any employees.
- Stock and Materials: This includes the cost of goods you sell or materials you use to provide a service.
- Insurance: This includes business insurance, such as professional indemnity insurance or public liability insurance.
- Training Costs: This includes training courses related to your business.
- Bank Charges: This includes fees for business bank accounts or credit card processing fees.
- Advertising and Marketing: This includes website costs, business cards, and online advertising.
Capital Allowances
If you purchase equipment or machinery for your business, you may be able to claim capital allowances. This allows you to deduct the cost of these items from your taxable profit. The Annual Investment Allowance (AIA) allows you to deduct the full cost of most plant and machinery (up to £1 million) from your profits before tax.
Personal Allowance
Everyone in the UK is entitled to a Personal Allowance, which is the amount of income you can earn before you start paying Income Tax. For the 2023/24 tax year, the Personal Allowance is £12,570. If your income is below this threshold, you will not need to pay Income Tax.
Marriage Allowance
If you are married or in a civil partnership and one partner earns less than the Personal Allowance, they can transfer up to £1,260 of their Personal Allowance to their partner. This can reduce the partner’s tax bill by up to £252 in the tax year.
VAT Considerations
If your turnover exceeds the VAT threshold (currently £85,000 for the 2023/24 tax year), you will need to register for VAT. Once registered, you will need to charge VAT on your sales and submit VAT returns to HMRC.
However, even if your turnover is below the VAT threshold, you can choose to register for VAT voluntarily. This can be beneficial if your customers are VAT-registered businesses, as they can reclaim the VAT you charge.
Seeking Professional Advice
Navigating the complexities of self-employment taxes can be challenging, especially in your first year. Seeking professional advice from an accountant or tax advisor can help ensure that you are meeting all your tax obligations and taking advantage of any available tax reliefs and allowances.
An accountant can also help you with:
- Setting Up Your Business: An accountant can advise you on the best legal structure for your business (sole trader, partnership, or limited company) and help you set up your accounting systems.
- Tax Planning: An accountant can help you plan your taxes to minimize your tax liability and ensure that you are making the most of available tax reliefs and allowances.
- Filing Your Tax Return: An accountant can prepare and submit your Self Assessment tax return on your behalf, ensuring that it is accurate and submitted on time.
- Dealing with HMRC: If you have any issues or disputes with HMRC, an accountant can represent you and help resolve the matter.
Common Mistakes to Avoid
In your first year of self-employment, it’s easy to make mistakes when it comes to taxes. Here are some common pitfalls to avoid:
- Not Registering on Time: Failing to register with HMRC by the October 5th deadline can result in penalties. Make sure you register as soon as possible after starting your business.
- Not Keeping Accurate Records: Keeping accurate records is essential for completing your tax return and claiming allowable expenses. Make sure you keep all receipts, invoices, and bank statements.
- Missing Deadlines: Missing the deadlines for submitting your tax return or making tax payments can result in penalties and interest charges. Make sure you are aware of the deadlines and set reminders to ensure you meet them.
- Not Claiming Allowable Expenses: Failing to claim allowable expenses can result in paying more tax than necessary. Make sure you are aware of what expenses you can claim and keep records of all business-related costs.
- Not Making Payments on Account: If your tax bill is over £1,000, you will need to make payments on account. Failing to do so can result in penalties and interest charges.
- Not Seeking Professional Advice: Tax rules and regulations can be complex, and it’s easy to make mistakes. Seeking professional advice can help ensure that you are meeting all your tax obligations and taking advantage of any available tax reliefs and allowances.
Planning for the Future
As you become more established in your self-employment, it’s important to plan for the future. This includes setting aside money for taxes, building an emergency fund, and planning for retirement.
Setting Aside Money for Taxes
One of the biggest challenges for self-employed individuals is managing cash flow, particularly when it comes to setting aside money for taxes. A good rule of thumb is to set aside around 25-30% of your income for taxes. This will help ensure that you have enough money to cover your tax bill when it comes due.
Building an Emergency Fund
As a self-employed individual, your income may fluctuate, and you may face unexpected expenses. Building an emergency fund can help you weather any financial storms and ensure that you can continue to meet your tax obligations.
Planning for Retirement
Unlike employees, self-employed individuals do not have access to an employer-sponsored pension scheme. It’s important to start planning for retirement early and consider setting up a personal pension or other retirement savings plan.
Conclusion
Your first year as a self-employed individual in the UK can be both exciting and challenging. Understanding when and how to pay taxes is crucial to ensuring that you remain compliant with HMRC and avoid penalties. By registering with HMRC, keeping accurate records, completing your Self Assessment tax return on time, and seeking professional advice when needed, you can navigate the complexities of self-employment taxes with confidence.
Remember, being self-employed comes with a great deal of responsibility, but it also offers the freedom to build a business on your own terms. By staying organized, planning ahead, and taking advantage of available tax reliefs and allowances, you can set yourself up for long-term success as a self-employed individual in the UK.