Tax management for the self-employed

Tax rules for the self-employed are quite different to those for salaried workers, whose tax is collected via the Pay As You Earn (PAYE) system.

With PAYE, tax and National Insurance contributions are automatically deducted from your wages.

But when you’re self-employed, you are required to prepare your own tax statements and submit them to HMRC via a Self-Assessment tax return form. This often catches out the newly self-employed, with many finding themselves facing an unwelcome and unexpectedly large tax bill after their first year.

When you’re self-employed and a sole trader, the tax you’re required to pay is based on the profits of your business, instead of how much income you choose to draw from the business itself.

However, if you are self-employed and a director or partner in a limited company, you can reduce the amount of tax you pay by choosing to take a combination of salary and dividends from the company.

In both cases, your business profits will be calculated over a 12-month period. It’s important to keep records of all your business incomings and outgoings to help with completing your Self-Assessment.

The tax you’re required to pay is usually payable in two instalments. The first instalment covers the full year of trading, and must be paid by 31 January, and the second instalment (known as ‘payment on account’) is often required by 31 July. This second payment is based on your previous tax bill, and is an advance payment designed to spread the tax you pay more evenly throughout the year.

The latter might come as a surprise to the newly self-employed, so it’s important to set aside money on a regular basis to avoid any difficulties in paying.

Depending on how much your business earns, you may also need to register for VAT – and make VAT payments each quarter – as well as paying business rates or other property taxes.

If being self-employed leaves you facing larger tax bills than you had expected, the first step is to make sure you’re claiming all available expenses associated with your work. Any expenses incurred as a result of running your business can be offset against the profits you make, reducing the amount of tax you’re required to pay.

Expenses can include things like:

If you work from home, you can claim several ‘allowable expenses’, including a percentage of your utility bills, as well as the use of an office in your home.

If you’re a sole trader, it might also be worthwhile checking whether you’d be financially better off switching your status to limited company. While this would mean you’d be liable for corporation tax, you might find the combination of salary and dividends is more tax-efficient, depending on your income requirements.

Tax planning can be particularly helpful if you have specific business plans in mind, such as buying another business, or selling your current business. However, it’s important to talk to a professional financial planner before making any key decisions. They can help you work out the most appropriate course of action, while avoiding any unforeseen pitfalls.

One of the simplest ways for the self-employed to reduce the amount of unnecessary tax they pay is to make sure they’re taking full advantage of any annual tax allowances and reliefs, which the government makes available.

An independent financial planner can work with you to identify where you can benefit from allowances relating to income tax, capital gains tax and dividend income, as well as making tax-efficient contributions to Individual Savings Accounts (ISAs) and pensions.

A financial planner can also determine whether you might benefit from other tax-efficient investment vehicles, such as Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS), which offer several tax incentives in return for investing in smaller companies. However, these types of vehicles are higher risk than traditional investments and may only suit the more sophisticated investor. Another reason why it’s important to get independent financial advice before investing.

Many self-employed people are independently minded by nature, and there’s often a natural temptation to take a do-it-yourself approach to financial and tax matters.

But after you consider the complicated nature of tax planning, the challenge of keeping up with the latest tax regulations, and the time-consuming nature of doing all the research and calculations yourself, you may find that working with a tax planning professional makes better financial sense. In fact, it could result in efficiencies and savings that reduce the tax you pay and increase your income.

At Amber River, our independent financial planners can work with you to create a financial plan based on your individual circumstances. More importantly, if you have specialist tax planning requirements, we can also introduce you to an accountant who will work alongside our planner to help deliver a comprehensive tax planning service.

Running your own business can be hectic and stressful, but we’re here to make sure that managing your taxes is one less thing to worry about.