The tax system for the self employed
All your profits or losses from your self employment become your income and will be subject to income tax and Class 4 National Insurance Contributions (NICs). You must also pay Class 2 NICs at a flat rate and potentially capital gains tax if you make a profit on any capital assets of the business. The current tax rates and NICs for self employed individuals can be found here:
Self assessment tax returns
As a self employed individual, you must complete and file a self assessment tax return no later than 31 January (if filed online) or 31 October (for paper returns), following the end of the tax year in which your income or losses arose. For example, if your annual accounting date is 31 March 2018, you must file your tax return no later than 31 January 2019 (if filed online) or 31 October 2018 (for paper returns).
If you are in a partnership, the 'nominated' partner must also complete and file a partnership tax return each tax year in addition to their self assessment tax return.
Paying tax and NICs
Self employed individuals pay tax and Class 4 National Insurance Contributions in two instalments. These are called 'payments on account' and are due on 31 January and 31 July each year (except in your first year of trading). Each of these interim payments will be based on one half of the total liability for the previous tax year. However, you do have the right to reduce payments on account if you believe your income tax for the following tax year will be lower.
A balancing payment or refund is then due on 31 January each year, along with the first payment on account for the current tax year. Class 2 NICs are also due at a flat rate and are payable at the same time.
Starting and ending a business
You should inform HMRC immediately if you become self employed or set up a partnership or company. Heavy penalties can be imposed for failure to notify and for failure to keep records.
Don't forget to claim for pre-trading expenditure. You can claim for expenses incurred in the 7 years prior to commencement of trading in your first year. The expenses are treated as incurred on the first day of trade.
When you sell a business or dispose of assets after ceasing to trade, there are various reliefs available to reduce your potential tax liability. We can guide you through the various options available to you when the time arises. See Capital gains tax and Inheritance tax and gifts for further information.
All taxpayers must retain all records required to enable them to deliver a correct tax return. This includes personal and business records. Records must be retained until 5 years after the 31 January following the tax year where the taxpayer is in business (almost 6 years). The maximum penalty for each failure to retain records is £3,000 per tax year.
Losses in your first 4 years of trading can be offset against other income, perhaps from a former employment, in the same tax year or the previous 3 tax years, instead of carrying the losses forward to offset against future profits that may never materialise.
On the cessation of a trade, a loss arising in the last 12 months of trading can be set against trade profits of the tax year of cessation and the previous 3 years, taking the latest year first.
All other trade losses can be set against general income in the same tax year and/or the preceding year. The balance of any losses can then be carried forward to set against the first available profits of the same trade.
It is important to choose the most tax efficient and quickest way of relieving losses as this can save you a lot of tax. This may depend on income and tax paid in earlier years and whether the business expects to generate profits in future years. We can help you decide on the most appropriate ways of utilising losses.
If you make a loss or earn less than £6,205 per year (2018/19), you do not have to pay any Class 2 NICs, although you may need to consider whether you need to retain your national insurance record to be eligible for state benefits and the state pension in the future.
Use of home
If you carry out work from home at any time as part of your trade, you can deduct a proportion of your household bills from your profits. There are some flat rate allowances available, but you must keep records of your expenses if you wish to claim more. There may however be a capital gains tax charge if you use part of your home solely for business purposes.
Vehicle expenses or mileage allowance?
If your turnover is less than the current VAT registration limit (£85,000 – 2018/19), you have a choice of how to claim vehicle expenses. You can either:
- claim capital allowances for the cost of the vehicle and running expenses, or
- you can claim the approved mileage allowances (45p for the first 10,000 miles for cars/vans, 25p thereafter).
But once you have chosen, you have to use the same method every tax year until you dispose of the vehicle. If your turnover is higher than the VAT threshold you must use the first method.
If you use your vehicle for both business and private use, you must make an allowance for the private use and disallow a proportion of your expenses and purchase cost.
You can employ your partner or children (if aged 13 or over) in your business to make use of their personal allowance and therefore save your family and your business tax as a whole. However, they must actually carry out work in the business and be paid a realistic rate for doing so. The National Minimum Wage rules also need to be considered.
If you need to wear protective clothing to carry out your trade, you can deduct the cost of these items including the associated laundry costs. However, you cannot deduct the cost of ordinary clothing. You can also deduct the cost of eye tests from your profits if you spend most of your working time using a computer.
There are various VAT schemes available such as the flat rate scheme and cash accounting scheme which might benefit your business. We can help you decide which schemes might be appropriate for your business and your circumstances.
You might want to consider salary sacrifice schemes and paying employees tax free benefits in exchange for part of their salary. Employers and employees can benefit through paying less NICs on the salary payments. An example of this is childcare vouchers schemes.
Income and allowable expenses
Please read the following pages to learn more about how different types of income and expenses are treated for self employed persons:
Please read the following pages to learn more about how capital allowances work and how they can reduce your tax liabilities:
This information is not meant as a substitute for professional advice and by no means covers every scenario. Almost every rule described here will be subject to many exceptions and caveats. Tax legislation is extremely complex and can be difficult to understand. You should discuss your circumstances with a qualified professional before acting on any information contained within this website. Tax legislation is constantly changing and the information contained within this website is written from our current understanding and interpretation of the tax system as of 6 April 2018.
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