Newly self-employed? Check out our Top 10 tips to manage your tax and National Insurance
In the current economic climate, more people may be thinking of starting their own business as a means of making some extra cash, either as a primary or secondary source of income. Below we set out our top 10 tips for keeping on top of the tax and National Insurance aspects of self-employment.
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1. Are you really self-employed?
Most people will know if they are self-employed as they will be working for themselves, either selling goods or supplying services to others to make a profit. They will often only be paid once an invoice has been issued at the end of a transaction such as on delivery of goods or completion of a service.
However, for others, knowing whether you are self-employed can be a grey area. If you are not sure, we suggest you read our detailed guidance on the factors to consider when deciding whether you are in fact self-employed.
Some common areas of confusion include:
- Working through your own limited company
Although in this situation you may think you are working for yourself, you are actually working for your company as an employee and so you are NOT self-employed. For more information on this see our guidance: I work through a limited company: what is my position?.
- Working in the building industry as a sub-contractor, within the Construction Industry Scheme (CIS)
Although tax may be deducted from pay when you work as a sub-contractor, you are self-employed if you come within the CIS and not employed. For more information on this, see our guidance: What is the construction industry scheme (CIS)?.
- Selling items using auction or marketplace websites
In this situation, whether you are self-employed or not will usually depend on the nature of the transactions and their frequency – if the activity is regular, organised and with a view to making a profit then this is likely to be trading and so classed as self-employment. However, if the transactions are sporadic and involve sales of personal items no longer required then this will not be trading.
- Working in the gig economy
If you earn money by using one of the many online platforms to, for example, offer rides, run errands, make deliveries, you will usually be self-employed. See our factsheet Tax if you work in the gig economy for more detail on this and other relevant areas of tax for gig economy workers.
2. Are you exempt from registering as self-employed with HMRC due to the trading allowance?
A trading allowance of £1,000 was introduced for the 2017/18 tax year onwards. Therefore, if the total trading income (from all your self-employment businesses) in your accounting period is less than £1,000 you may not need to register as self-employed with HMRC. This might be relevant when your self-employment first begins or if your business is run on a relatively small scale to provide you with ‘top-up’ income. However, there are some situations where you may still want to register as self-employed even though your income is less than the trading allowance.
Our Trading Allowance factsheet has more details about this allowance, including its interaction with other areas such as tax credits, universal credit and student loans.
3. Don’t delay notifying HMRC that you are self-employed if you need to register for Self Assessment
If you are self-employed and are not exempt from completing a Self Assessment tax return due to the trading allowance (see above), then you should register as self-employed with HMRC as soon as possible. Although the deadline to register is 5 October after the end of the tax year in which your self-employment started, it is best to allow lots of time for your registration to be processed and your unique tax reference number (UTR) to be issued.
There is more information on registering as self-employed in our section How do I register for tax and National Insurance?.
If you already have a UTR, perhaps because you have been self-employed in the past, or you complete a tax return every year for a different reason, you still need to register as self-employed so that your National Insurance contributions are calculated correctly.
HMRC can charge you a penalty if you miss the deadline. This is explained in more detail in our guidance What happens if I do not register or register late?.
4. Set up your business record keeping processes from the start
It is important to keep records of your business income and expenses as soon as your business begins so you can complete your accounts and submit an accurate tax return. There are various ways you can set up and maintain business records, see: What business records should I keep?.
- Pre trading expenses
If you had expenses to pay while setting up the business, for example, buying equipment like a computer, paying rent for premises, or buying stock you should record these as well. You may have started to use equipment which you already owned personally for your business, in which case you should record what you think the value of these assets are when you begin trading. These expenses are known as pre-trading expenses and they qualify for tax relief too in the same way as other business expenses, see Can I claim for pre trade expenses?.
- Annual accounting period
When setting up your record keeping systems, you need to decide your business’s accounting period end date. If you want to keep things simple, use an accounting date of either 31 March (if you prefer to work in whole months) or 5 April so it matches the tax year. Our page How do I work out my taxable profits? explains further.
- Cash basis or accruals basis?
You will also need to decide if you will prepare your accounts (and tax return) using the cash basis or the accruals basis (traditional accounting). This can sound rather complicated, but the cash basis is more straightforward as you record your sales when you receive payments and your expenses when you actually pay for them, however there are more restrictions using the cash basis if you make losses or have finance costs such as interest on business loans. Our page How do I prepare my accounts? explains in more detail.
- Digital record keeping
HMRC’s Making Tax Digital initiative includes a legal requirement to keep business records digitally if you have to be VAT registered. It has recently been announced that all VAT registered businesses (including those voluntarily registered) will need to meet this legal requirement from 2022, and that businesses with a turnover of £10,000 or more will be required to keep records digitally from 2023.
5. Set funds aside for your tax payments as you go
It is best to try to put some funds aside each time you receive an income payment so that you have some money to hand to pay your tax bill when it becomes due. Typically, payments will be needed in January each year, and also possibly in July each year if you come within the payments on account system.
Our guidance When do I pay income tax on self-employed profits? explains when tax is due and also looks at the payment on account regime.
Our factsheet Self-employed: don’t get caught out by payments on account also has several useful examples of how payments on account work, and indicates amounts to set aside according to the level of your self-employed profits when self-employment is your only source of income.
6. Keep an eye on the level of your payments on account
Payments on account are automatically fixed according to the income tax and Class 4 National Insurance contributions (NIC) bill for the previous tax year. This is fine if your profits are fairly steady, but if they tend to fluctuate you should keep the amount of your payments on account under review.
If your profits are likely to be less than the previous year and you expect your overall income tax and NIC bill to be less than the previous year too, then you can apply to reduce the level of your payments on account so that you don’t make excessive ‘on account’ payments. We show you how this works in our guidance: What are payments on account?.
If you expect your profits to be more than those for the previous year, you do not need to increase the level of your payments on account for that year, they just remain fixed at the level of your previous year’s tax bill.
See also our factsheet Self-employed: don’t get caught out by payments on account for more information.
7. Consider paying Class 2 NIC voluntarily even if your profits are below the small profits threshold
As a self-employed person, you may have to pay both Class 2 and Class 4 National Insurance contributions (NIC) if your profits exceed the relevant thresholds.
If your profits are below the thresholds, you are not required to pay the contributions for that tax year. However, if you are not receiving National Insurance credits due to your particular circumstances, you might wish to pay the Class 2 contributions voluntarily, even if your profits are below the Small Profits Threshold (£6,475 for the 2020/21 tax year).
This would mean your National Insurance record would be credited with another year’s contributions and so it may enhance your entitlement to some state benefits including the state pension and maternity allowance. See also: Why might I choose to pay class 2 NIC even if my earnings are below the Small Profits Threshold?.
8. Do you need to consider VAT?
Value-added Tax (VAT) is a complicated tax, and is based on the turnover (sales) of the business. Not all businesses need to be VAT registered.
Broadly, if your turnover in ANY consecutive 12-month period exceeds the VAT registration limit (£85,000 for the 2020/21 tax year) then you have to register for VAT and, once registered, account for VAT on your sales. See Do I have to pay VAT if I am self-employed? for some VAT basics, but we recommend taking professional advice if you need to register for VAT.
Some businesses with turnover below the VAT threshold choose to register voluntarily. If you are considering voluntary registration, you should take professional advice.
9. Keep different self-employments separate
If you have more than one activity that you are carrying out on a self-employed basis, you will need to keep the different businesses separate for tax purposes. This means recording the income and expenses separately for each business, preparing separate accounts and completing self-employed pages for each self-employment on your Self Assessment tax return.
Our guidance for people with multiple trades shows how to make sure the tax and National Insurance is calculated correctly in these circumstances and also explains how the trading allowance applies and how losses are treated when there is more than one trade.
10. Don’t panic: there is lots of help out there
When you start a business, whether on a small scale or something more substantial, it can be quite daunting as there are so many things to think about and keep track of. If you can afford to engage a professional adviser, we recommend you choose someone who is well qualified to assist you, such as a Chartered Tax Adviser.
However, if you cannot afford a professional adviser, there is lots of ‘do it yourself’ help available too. There is detailed information and examples in the Self-employment section of our website. We have also produced a booklet which can be downloaded: Self-employment: A LITRG guide.
Our Getting help page signposts to third party sources who can provide help and assistance in a variety of circumstances including the tax charity TaxAid, which provides free advice to those who cannot afford professional help.