Tax and National Insurance in Self-Employment

If you’re self-employed, it’s your responsibility to pay tax and National Insurance for yourself. This can be a scary responsibility, and sometimes quite confusing. To help you understand the shape of the UK tax system, and how you fit into it as self-employed, we’ve written this blog on tax and National Insurance for the self-employed.

This blog will talk you through:

• How to work out your employment status
• The amount of National Insurance you’ll pay, plus how and why
• The tax you have to pay as self-employed, including VAT
• The tax relief you’re entitled to as self-employed

Work out your employment status

In order to work out how much tax and National Insurance you need to pay, you need to work out whether you are actually employed or self-employed.

As you can be employed in one job and self-employed in another, the distinction isn’t always clear.

You can check your employment status for tax using HMRC’s Employment Status Indicator. This is a questionnaire that helps you work out your employment status for each job you have.

Tip: when answering the questions, remember that you are the “worker” and anyone you work for is the “engager”.

Register as self-employed

If you haven’t already, you need to register as self-employed with HMRC. Click here to learn how to register as self-employed.

Budgeting for self-employed tax and National Insurance

Once you’re registered, your next step will be to start budgeting for your tax bill. This helps you distribute the cost through the year and avoid a nasty surprise when your bill arrives.

1. You can use the self-employed ready reckoner to budget your tax bill for the year ahead.
2. You can also make use of a range of financial reports to track your own finances and make sure you’re moving in the right direction.

Paying National Insurance contributions as self-employed

As a self-employed individual, you’ll need to pay National Insurance contributions (NICs). These currently include:

• Class 2 National Insurance contributions, which is a flat rate charge on self-employed individuals.
• Class 4 National Insurance contributions, which are based on the profits you make.

You will only pay NICs between the ages of 16 and state retirement age.

Why you pay National Insurance contributions

Your contributions pay towards your basic state pension, maternity allowance and bereavement benefit.

Other state benefits include:

• Contribution-based employment and support allowance
• Widowed parent’s allowance
• Flat-rate state pension

If you don’t keep your payments on time and up to date, it could be difficult to claim your benefits when you need them. This is why some people voluntarily pay NICs even when they don’t have to.

Please note that Class 4 NICs don’t contribute towards any state benefits.

How much National Insurance you have to pay

If your profits are over £6,025 a year, then you’ll pay Class 2 contributions. In the tax year 2017 to 2018, Class 2 NICs are £2.85 per week.

If your profits are over £8,164, you’ll pay Class 4 contributions. Class 4 NICs are currently 9% on profits between £8,164 and £45,000, then 2% on profits over £45,000.

To calculate your profits, simply deduct your expenses from your self-employed income.

How to pay National Insurance

The majority of people pay NICs through Self-Assessment, which you’ll learn more about in the self-employed tax section below.

Before you do this, you need to make sure you are registered as self-employed with HMRC.

Class 4 NICs are paid with your income tax liabilities through the self-assessment system. Class 2 NICs are also paid via self-assessment, as part of the payment due 31 January after the end of the related tax year.

You can access the self-assessment payment portal here.

What are voluntary National Insurance contributions?

If your self-employed profits are below £6,025 per year, which is the Small Profits Threshold, then you don’t have to pay National Insurance Contributions.

Some (such as land and property owners, religious ministers that don’t receive a salary, investors who don’t get a fee or commission and exam moderators / invigilators) don’t have to pay NICs but want to.

These are called voluntary contributions. People voluntarily pay NICs because it protects their eligibility for state benefits (as mentioned above).

Changes to National Insurance contributions

As of April 2018, Class 2 National Insurance contributions will be abolished. The aim of this is to make self-employed NICs easier to understand and file, and make the NICs system fairer and more available to everybody. 

What tax do you have to pay as self-employed?

Most self-employed tax can be paid via Self-Assessment. This is a standard tax return form for self-employed businesses. It will include a report of your annual earnings and the sources of these earnings. Your Self-Assessment form is sent to HMRC.

What are the fines for late tax payments?

If you file your tax return late by up to 3 months, you’ll have to pay a penalty of £100.

If your tax return is filed even later, or you don’t pay your tax bill, then you may have to pay a larger fine. You can use HMRC’s Self-Assessment penalty calculator to find out how much you’d owe.

If you want to appeal against a fine, you can do so if you have a reasonable excuse. HMRC considers reasonable excuses to include:

• Death of a close partner or close partner shortly before the payment deadline
• Unexpected stay in hospital that prevent you from finishing tax returns
• Service issues with HMRC, or a computer/software failure on your part
• Another event, such as fire or flood, that kept you from filing

You can learn more about HMRC’s appeal policy here.

What are the deadlines for Self-Assessment?

The deadlines for Self-Assessment (2017) are:

Tips for filing your tax return

Make sure you register on time and have all the relevant information to hand. If you earned more than £8,500 – you’ll need your P60 form, your P11D and any payslips you’ve collected.

You’ll need interest statements, details of pension contributions and other information like Gift Aid donations to include on your form. If you need to contact banks and building societies about this, make sure you do so ahead of schedule so that you aren’t delayed by third parties.

When you fill in the tax return form, take your time and double check everything. In the online version, you get reminders about where required information can be found – such as on your P60 or P11D form.

The online tax return automatically updates as you fill it in, meaning irrelevant sections are removed. This can save you time, but also means you have to make sure your answers are correct.

If you’re struggling to concentrate, or making mistakes, you can save the online tax return and come back to it later. If you start well enough in advance, you can afford the time needed to get it right.

Do I need to register for VAT as self-employed?

For the self-employed, VAT applies:

• If your VAT-taxable turnover is more £83,000 in a 12 month period.
• If you receive goods in the UK from the EU worth more than £83,000.
• If you expect to go over the threshold in a 30-day period, regardless of whether the overall value is less than that at the end of 12 month period.

If any of those scenarios apply, then you’ll have to pay VAT and file a VAT return every quarter. Key to doing this successfully is keeping your books in order.

Tips for self-employed VAT

You have to take VAT into account even if you receive goods and services in exchange for your work. You also have to take it into account even if you don’t charge VAT to your customers. In these instances, you’d pay the VAT equivalent.

Make sure you claim back VAT on applicable fixed assets and on items that don’t have VAT.

If you’re a VAT-registered business, you must keep your VAT records for at least 6 years. You must also keep records of sales and purchases, keep a VAT account and issue correct VAT invoices.

KashFlow’s software is directly linked to HMRC, and offers all of these features plus a live VAT liability total that helps you keep track of how much VAT is owed at any one time – essential for proper budgeting.

VAT rates for self-employed

The majority of goods and services come under the 20% standard VAT rate. Some goods and services, like home energy, are at the reduced VAT rate of 5%. Others, including most food, have a zero rate.

As a self-employed individual, you should look into the Flat Rate scheme. With this, you’ll pay a fixed rate of VAT and keep the difference between what you charge to customers and what you pay to HMRC.

With the Flat Rate scheme, you can’t reclaim the VAT from your purchases unless it is on a capital asset valued over £2,000.

You can learn more about the Flat Rate scheme and VAT procedures in this free guide for small businesses.

What tax relief are you entitled to as self-employed?

If you’re self-employed, then you can deduct some the business’s running costs (called allowable expenses) from your pre-tax profits.

Allowable expenses can include:

• Office costs such as stationary or phone bills
• Location costs like heating, lighting and business rates
• Business travel costs including fuel, parking and public transport fares
• The cost of uniforms and other clothing expenses
• Staff costs such as salaries or contractor fees
• The cost of stock or materials you’ve bought to sell
• Advertising costs, including the cost of running a website

So if, for example, your turnover is £26,000 and you claim £4,000 in allowable expenses – your taxable profit is reduced to £22,000. This means you get £4,000 tax-free.

What are capital allowances?

If you buy assets for your business, such as equipment, machinery or vehicles, then you can deduct some (or all) of their value from your pre-tax profits. These are called “plant and machinery” allowances.

The value of your business asset is normally the amount you paid for it. If it was pre-owned or a gift, then use its market value – which is the amount you expect it to sell for.

You can also claim capital allowances for:

• Research and development
• Renovating premises in disadvantaged areas
• Extracting minerals
• Dredging
• Patents

In addition to the cost of the assets you keep for use in your business, you can also claim capital allowance for:

• Costs of demolishing these assets
• Integral building features like lifts, air-conditioning and electrical systems
• Fixtures like fitted kitchens and bathroom suites
• Alterations needed to install these assets, excluding repairs

There’s a full list of what you can claim on here.

What is annual investment allowance?

You can deduct 100% of the cost of certain assets, including most plant and machinery allowances, from your taxable profit.

The government sets a limit for how much annual investment allowance you can claim in a year, which is currently £200,000.

What is cash basis?

If you’re a sole trader or partnership, you can use cash basis to calculate your income and expenses as part of the Self-Assessment tax return. When you use cash basis, you only declare money when it comes into and leaves your business. This means you don’t pay Income Tax on money you didn’t receive.

You can use cash basis if you have a turnover of less than £150,000 per year. If you run multiple businesses, their combined turnover must be below this limit.

You can learn more about cash basis here.

Keeping records

As you can tell, tax and National Insurance can be a bit of a headache – especially when it’s all new. KashFlow can help in two ways.

Firstly, we work with a number of accountants, who can offer you personalised advice on the types of tax you’ll be liable to pay and the types of relief you can claim in your unique situation. They can also help you file your tax returns. Search for an accountant here.

Secondly, we can help you keep your books in order and under your control. This means that, when the time comes to file your tax return, you already have all of your information in one, easy-to-navigate place.

For a free demo of KashFlow Online Bookkeeping Software, call our team on 0344 815 5779. Alternatively, you can jump straight in and try it yourself with a free trial