Taxes to pay when you’re a freelancer
It’s a thrilling step to go it alone as a freelancer – be your own boss, say goodbye to the 9-to-5 and have the freedom to choose who you work with. But it also means you’re in charge of a brand new financial responsibility. We’re talking tax – the money you and your business need to pay to Her Majesty’s Revenue and Customs (HMRC) from your profits.
What type of taxes will I have to pay?
In a nutshell, the tax you’ll pay depends on how you set up your business. Here’s a simple breakdown for each scenario:
- Become a sole trader / self-employed
This is the simplest sort of business – it’s just you. When customers pay your invoices, they’re actually paying you directly – so you must declare any payments as untaxed income to HMRC via the self-assessment system each year. You’ll face paying both income tax and national insurance (NI) contributions, depending on your profits.
- Enter into a partnership
A partnership is essentially two or more people working together as sole traders.
Each partner must declare their untaxed income (their share of the revenue) via self-assessment, while one of you must also be ‘nominated’ to also submit a separate tax return for the partnership itself and keep records (though there isn’t a separate tax bill for this).
- Set up a limited company
This is where things get a little more complicated. A limited (LTD) company is a separate legal entity so when a customer pays an invoice, they’re paying the business – not you, as a director running it.
As a director, you must still declare the company’s turnover to HMRC and use the company bank account to pay any corporation tax owed.
Each director may also need to pay tax on money taken out of the business as salary and dividends, through some combination of payroll PAYE (Pay As You Earn) and self-assessment.
Is there VAT to pay?
A business only has to charge its customers value added tax (VAT), and pay a VAT bill to HMRC, once its turnover goes over a certain threshold.
Even if you don’t meet the thresholds, you can register for VAT. Why? It may mean more financial admin, but a business can also reclaim VAT paid on company purchases – a useful way to save money, especially if set-up (or ongoing) costs are high.
The VAT rate you levy will also depend on what goods or services you sell – 0% on children’s clothes, for instance, compared to the standard 20% for most goods and services. As a rule, your VAT returns are typically due – and payable – every three months.
Do I need to register with HMRC?
Once you’ve decided on the type of business you want and how to run it, you’ll need to work out which types of tax you and your business are liable for – and notify HMRC, where needed.
If you’re managing your accounts yourself, this is all best done online for ease and convenience.
- Register for self-assessment
If you’re setting out as a sole trader or partnership, start by registering for online self-assessment. All sole traders who earned more than £1,000 in the previous tax year – as well as all members of a partnership – must submit an annual tax return via self-assessment. The need to do so isn’t as clear cut for company directors, but HMRC has an online tax return tool to help you here.
- Register your business
If you’re a partnership, the ‘nominated partner’ must also register the partnership with HMRC.
Decided to run your firm as a limited company? You (or another director) must register for corporation tax.
If you’re a sole trader, you can trade under your own name or choose a different one for your business – and don’t need to register its name. However, you must include your name and business name (if you have one) on any official paperwork, such as invoices and letters.
- Register for VAT
As mentioned above, registering for VAT is optional if your turnover is below a certain threshold, but compulsory if it goes above it
How much tax do I have to pay?
- Sole traders / partnerships
Your income tax payment is based on the income tax rates and personal allowances for the previous financial year (the 12 months to 5 April). You’ll be told how much you owe as soon as you complete your online self-assessment.
As well as paying tax for the last financial year’s work, you’ll also be asked for a ‘payment on account’ for the current year (that is, the one you’re part-way through by the time you complete your self-assessment) – in other words, you’ve to pay a lump sum in advance. We’ll leave it to HMRC to explain why, but this actually means your tax bill each 31 January will be higher than that worked out on your tax return.
- Limited companies
A limited company submits an annual return for corporation tax, but HMRC doesn’t work out what’s owed – that’s up to you or the other directors, based on the accurate and detailed records of income and spending you must keep.
Any income tax paid by you or a director via PAYE depends on the salary, but this is deducted before that salary is paid. While this means a director doesn’t necessarily need to declare their salary via self-assessment, it’s vital that the payroll is managed by a set individual at the company.
If money is paid to directors as dividends, these may also need to be declared and tax paid via self-assessment – HMRC’s tax return tool helps here.
Plan for your tax payments
HMRC takes a very dim view of late or non-payment of tax, so having enough money in the bank to pay a bill is a must.
If you’re a sole trader or even a partnership – especially one starting out - you can use an ordinary personal current account to receive invoice payments and then switch money into a separate savings account for tax (and into another account for VAT if needed).
This way, the money you owe to HMRC won’t artificially inflate your current account – and you’ll be less tempted to spend it on something else. By the time each tax bill is due, you should have enough saved to cover it comfortably.
How much you need to set aside depends on your revenue (or revenue split, for a partnership), but each year’s income tax bands will help your calculations here – and don’t forget that NI contributions are paid through self-assessment too.
It’ll be a much more complex arrangement if you’re running a limited company because of the additional bookkeeping requirements and the need to pay multiple types of tax. In this case, it’ll be worth considering whether to hire an accountant. And as your business grows in size, it’ll also be worth weighing up a business bank account to manage your payments.
Terrified of tax? Try an accountant
If any of this sounds daunting, then an accountant is a worthwhile business expense and certainly a better option than being fined by HMRC. Don’t rule out DIY, though – good online accounting software can do most of the hard work for you. Some accountants even include this as part of their fee, so you can watch what they’re doing with your accounts and learn some basics in the process.
Start by asking friends or fellow freelancers for any personal accountant recommendations, or research – and review customer feedback – affordable accounting software on your web browser.
The article above is a guide only and does not constitute professional advice. Barclays does not provide tax advice. Please consult the HMRC website or a personal tax adviser for further detail. Remember tax rules can change and their effects on you will depend on your individual circumstances.
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