How Much tax do Self Employed have to pay

How Much Tax Do Self-Employed Individuals Have to Pay in the UK?

Introduction

Becoming self-employed in the UK can be an exciting and rewarding venture. Whether you’re a freelancer, contractor, or running your own business, being your own boss offers flexibility and the potential for financial independence. However, with this freedom comes the responsibility of managing your own taxes. Understanding how much tax you need to pay as a self-employed individual in the UK is crucial to ensure compliance with HM Revenue and Customs (HMRC) regulations and to avoid any unexpected financial burdens.

In this comprehensive guide, we’ll explore the various taxes that self-employed individuals in the UK are required to pay, how to calculate them, and what steps you need to take to stay on top of your tax obligations. By the end of this blog, you’ll have a clear understanding of your tax responsibilities and be better equipped to manage your finances as a self-employed professional.

1. Understanding Self-Employment in the UK

Before diving into the specifics of taxes, it’s important to understand what it means to be self-employed in the UK. According to HMRC, you’re considered self-employed if you run your own business and take responsibility for its success or failure. This includes:

Freelancers and contractors
Sole traders
Partners in a business partnership
Individuals running their own businesses

As a self-employed individual, you’re responsible for managing your own taxes, National Insurance contributions, and other financial obligations. Unlike employees, who have their taxes deducted automatically through the Pay As You Earn (PAYE) system, self-employed individuals must report their income and expenses to HMRC and pay their taxes directly.

2. Types of Taxes for Self-Employed Individuals

Self-employed individuals in the UK are subject to several types of taxes, including:

2.1 Income Tax

Income tax is a tax on your earnings, and as a self-employed individual, you’ll need to pay income tax on the profits you make from your business. The amount of income tax you pay depends on your total taxable income, which is calculated by subtracting your allowable business expenses from your total income.

2.2 National Insurance Contributions (NICs)

National Insurance contributions are payments that help you qualify for certain state benefits, such as the State Pension and Maternity Allowance. Self-employed individuals are required to pay two types of National Insurance contributions:

Class 2 NICs: These are flat-rate contributions that you pay if your profits are above a certain threshold.
Class 4 NICs: These are based on your profits and are paid in addition to Class 2 NICs.

2.3 Value Added Tax (VAT)

Value Added Tax (VAT) is a consumption tax that’s added to the price of goods and services. If your business’s taxable turnover exceeds the VAT threshold (currently £85,000 as of 2023), you’ll need to register for VAT and charge VAT on your sales. You’ll also be able to reclaim VAT on your business expenses.

2.4 Corporation Tax (for Limited Companies)

If you operate your business as a limited company, you’ll need to pay Corporation Tax on your company’s profits. Corporation Tax is separate from income tax and is paid by the company rather than the individual.

2.5 Capital Gains Tax (CGT)

Capital Gains Tax is a tax on the profit you make when you sell or dispose of an asset that has increased in value. If you sell a business asset, such as property or equipment, you may be liable for CGT on the gain.

2.6 Business Rates

If you operate your business from a commercial property, you may need to pay business rates. Business rates are a tax on non-domestic properties, and the amount you pay depends on the rateable value of the property.

3. Calculating Income Tax for Self-Employed Individuals

Income tax is one of the primary taxes that self-employed individuals need to pay. Here’s how to calculate your income tax liability:

3.1 Determine Your Taxable Income

Your taxable income is calculated by subtracting your allowable business expenses from your total income. Allowable expenses are costs that are incurred wholly and exclusively for the purpose of running your business. Examples of allowable expenses include:

Office costs (e.g., stationery, phone bills)
Travel costs (e.g., fuel, train fares)
Clothing expenses (e.g., uniforms)
Staff costs (e.g., salaries, subcontractor costs)
Stock and materials
Marketing and advertising costs
Insurance
Bank charges and interest on business loans
Accountancy fees

It’s important to keep accurate records of your income and expenses to ensure that you claim the correct amount of allowable expenses.

3.2 Apply the Personal Allowance

Everyone in the UK is entitled to a tax-free 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 taxable income is below this threshold, you won’t need to pay any income tax.

3.3 Apply the Appropriate Tax Rate

Once you’ve determined your taxable income and applied the personal allowance, you’ll need to apply the appropriate income tax rate. The UK has a progressive income tax system, which means that the rate of tax you pay increases as your income increases. The income tax rates for the 2023/24 tax year are as follows:

Basic rate: 20% on income between £12,571 and £50,270
Higher rate: 40% on income between £50,271 and £125,140
Additional rate: 45% on income above £125,140

For example, if your taxable income is £60,000, you’ll pay:

20% on the first £37,700 (£50,270 – £12,570)
40% on the remaining £9,730 (£60,000 – £50,270)

This means your total income tax liability would be £7,540 (20% of £37,700) + £3,892 (40% of £9,730) = £11,432.

3.4 Deduct Tax Reliefs and Allowances

There are various tax reliefs and allowances that you may be eligible for as a self-employed individual, which can reduce your overall tax liability. Some common tax reliefs and allowances include:

Marriage Allowance: If you’re married or in a civil partnership, you may be able to transfer £1,260 of your personal allowance to your partner, reducing their tax bill.
Trading Allowance: If your annual trading income is £1,000 or less, you may be eligible for the trading allowance, which allows you to earn up to £1,000 tax-free.
Capital Allowances: If you purchase equipment or machinery for your business, you may be able to claim capital allowances, which allow you to deduct a portion of the cost from your taxable profits.

4. National Insurance Contributions for Self-Employed Individuals

In addition to income tax, self-employed individuals in the UK are required to pay National Insurance contributions (NICs). NICs help you qualify for certain state benefits, such as the State Pension and Maternity Allowance. There are two main types of NICs that self-employed individuals need to pay:

4.1 Class 2 NICs

Class 2 NICs are flat-rate contributions that you pay if your profits are above a certain threshold. For the 2023/24 tax year, the Class 2 NICs rate is £3.45 per week, and the threshold is £6,725. If your profits are below this threshold, you won’t need to pay Class 2 NICs, but you may still choose to pay them voluntarily to maintain your entitlement to certain state benefits.

4.2 Class 4 NICs

Class 4 NICs are based on your profits and are paid in addition to Class 2 NICs. For the 2023/24 tax year, the Class 4 NICs rates are as follows:

9% on profits between £12,570 and £50,270
2% on profits above £50,270

For example, if your profits are £60,000, you’ll pay:

9% on the first £37,700 (£50,270 – £12,570) = £3,393
2% on the remaining £9,730 (£60,000 – £50,270) = £194.60

This means your total Class 4 NICs liability would be £3,393 + £194.60 = £3,587.60.

4.3 Paying NICs

Class 2 and Class 4 NICs are usually paid together with your income tax through the Self Assessment system. You’ll need to include your NICs liability when you file your Self Assessment tax return.

5. Value Added Tax (VAT) for Self-Employed Individuals

5.1 VAT Rates

There are three main VAT rates in the UK:

Standard rate: 20% – This applies to most goods and services.
Reduced rate: 5% – This applies to certain goods and services, such as home energy and children’s car seats.
Zero rate: 0% – This applies to certain goods and services, such as most food and children’s clothing.

5.2 VAT Registration

If your business’s taxable turnover exceeds the VAT threshold, you must register for VAT with HMRC. Once registered, you’ll need to:

Charge VAT on your sales
Submit VAT returns to HMRC (usually every quarter)
Pay any VAT owed to HMRC
Reclaim VAT on your business expenses

5.3 VAT Schemes

There are several VAT schemes available to self-employed individuals, which can simplify the process of calculating and paying VAT. Some common VAT schemes include:

Flat Rate Scheme: This scheme allows you to pay a fixed rate of VAT to HMRC, based on your business’s turnover. The rate you pay depends on your business type.
Cash Accounting Scheme: This scheme allows you to account for VAT based on the payments you receive and make, rather than the invoices you issue and receive.
Annual Accounting Scheme: This scheme allows you to submit one VAT return per year, rather than quarterly returns.

6. Corporation Tax for Limited Companies

6.1 Corporation Tax Rates

The Corporation Tax rate for the 2023/24 tax year is 19% for profits up to £50,000. For profits between £50,001 and £250,000, the rate is 25%. For profits above £250,000, the rate is 25%.

6.2 Paying Corporation Tax

Corporation Tax is paid through the Company Tax Return, which must be filed with HMRC within 12 months of the end of your company’s accounting period. The tax is usually due nine months and one day after the end of your accounting period.

7. Capital Gains Tax (CGT) for Self-Employed Individuals

Capital Gains Tax (CGT) is a tax on the profit you make when you sell or dispose of an asset that has increased in value. If you sell a business asset, such as property or equipment, you may be liable for CGT on the gain.

7.1 CGT Rates

The CGT rates for the 2023/24 tax year are as follows:

Basic rate taxpayers: 10% on gains (18% on residential property)
Higher and additional rate taxpayers: 20% on gains (28% on residential property)

7.2 CGT Allowance

Everyone in the UK is entitled to a tax-free CGT allowance, which is the amount of capital gains you can make before you start paying CGT. For the 2023/24 tax year, the CGT allowance is £6,000.

7.3 Paying CGT

CGT is paid through the Self Assessment system. You’ll need to report any capital gains and pay any CGT owed when you file your Self Assessment tax return.

8. Business Rates for Self-Employed Individuals

8.1 Calculating Business Rates

Business rates are calculated by multiplying the rateable value of your property by the appropriate multiplier (set by the government). The rateable value is an estimate of the annual rent the property could be let for on the open market.

8.2 Small Business Rate Relief

If your business occupies a property with a rateable value of £15,000 or less, you may be eligible for Small Business Rate Relief. This can reduce your business rates bill by up to 100%.

8.3 Paying Business Rates

Business rates are usually paid in monthly or quarterly instalments. Your local council will send you a business rates bill, which will include details of how much you need to pay and when.

9. Record-Keeping and Self Assessment

As a self-employed individual, it’s essential to keep accurate records of your income and expenses. This will help you complete your Self Assessment tax return and ensure that you pay the correct amount of tax.

9.1 Record-Keeping Requirements

HMRC requires self-employed individuals to keep records of:

All sales and income
All business expenses
VAT records (if VAT-registered)
PAYE records (if you have employees)
Personal income

You should keep these records for at least five years after the 31 January submission deadline of the relevant tax year.

9.2 Self Assessment Tax Return

Self-employed individuals in the UK are required to complete a Self Assessment tax return each year. The tax return is used to report your income and expenses, calculate your tax liability, and pay any tax owed.

9.3 Deadlines

The deadlines for submitting your Self Assessment tax return and paying any tax owed are as follows:

31 January: Deadline for online tax returns and payment of any tax owed for the previous tax year.
31 July: Deadline for making your second payment on account (if applicable).

9.4 Penalties for Late Submission

If you fail to submit your Self Assessment tax return or pay your tax on time, you may be subject to penalties and interest charges. The penalties for late submission are as follows:

1 day late: £100 penalty
3 months late: £10 per day (up to a maximum of £900)
6 months late: 5% of the tax due or £300 (whichever is greater)
12 months late: 5% of the tax due or £300 (whichever is greater)

10. Tips for Managing Your Taxes as a Self-Employed Individual

Managing your taxes as a self-employed individual can be challenging, but there are several steps you can take to make the process easier:

10.1 Keep Accurate Records

Keeping accurate records of your income and expenses is essential for completing your Self Assessment tax return and ensuring that you pay the correct amount of tax. Consider using accounting software or hiring an accountant to help you manage your records.

10.2 Set Aside Money for Taxes

As a self-employed individual, you’re responsible for paying your own taxes, so it’s important to set aside money throughout the year to cover your tax bill. A good rule of thumb is to set aside around 25-30% of your income for taxes.

10.3 Make Payments on Account

If your tax bill is more than £1,000, you may be required to make payments on account. Payments on account are advance payments towards your next tax bill and are due in two instalments: 31 January and 31 July.

10.4 Claim All Allowable Expenses

Make sure you claim all allowable expenses when completing your Self Assessment tax return. This will help reduce your taxable income and lower your overall tax liability.

10.5 Seek Professional Advice

If you’re unsure about any aspect of your taxes, consider seeking professional advice from an accountant or tax advisor. They can help you navigate the complexities of the tax system and ensure that you’re paying the correct amount of tax.

Conclusion

Being self-employed in the UK comes with many benefits, but it also comes with the responsibility of managing your own taxes. Understanding how much tax you need to pay, how to calculate it, and what steps you need to take to stay compliant with HMRC regulations is essential for running a successful business.

By keeping accurate records, setting aside money for taxes, and seeking professional advice when needed, you can ensure that you meet your tax obligations and avoid any unexpected financial burdens. Whether you’re just starting out as a self-employed individual or have been running your own business for years, staying on top of your taxes is key to achieving long-term financial success.

Remember, the tax system can be complex, and it’s always a good idea to seek professional advice if you’re unsure about any aspect of your taxes. With the right knowledge and preparation, you can confidently manage your tax responsibilities and focus on growing your business.