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Information on the tax system when becoming self-employed

Information on the tax system when becoming self-employed

Mike Wakeford

Are you thinking of working for yourself, but unsure of the tax implications for the self employed?

 If you decide to become self employed, it is vital that you register with HMRC by 5th October following the end of the tax year in which you became self employed.  If you do not follow this process, you may be liable to a penalty based on the tax that is due to HMRC.

There are three ways to register with HMRC:
  • You can call the self employed helpline on 0300 200 4500
  • You are able to contact HMRC by post and can download and complete the CWF1 form, or use the form incorporated in SE1 – the form is titled ‘are you thinking of working for yourself?’
  • Online – registering online may be considered the easiest way to register with HMRC. You can click here to visit the website and register self employed. 
Once you have registered to become self employed you will notice that the tax rules are different from those that may have applied when you were an employee. When you are an employee your tax and national insurance is deducted from your earnings at source, however when you are self employed you must be prepared to receive a bill at some point to make payment for both your tax and national insurance contributions. It is good to keep this in mind and to budget for it. 

What profits will HMRC tax?

HMRC will begin the calculation of taxable profits by looking at your profit and loss account. When calculating taxable profits you are entitled to claim deductions from your business income in respect of any expenses incurred for the purpose of trade. 

For most of the equipment that you buy for your business you are entitled to deduct the full cost (which can be up to a maximum of £1 million in the year to 31 December 2020 and then up to £200,000 from January 2021). Laptops, computers for example, that you will need to carry out your day job as self employed are all included in the equipment needs for your business. For most cars, you are able to deduct only a proportion of the cost for each year, based on the amount of business use compared to private use of the car.

How is tax payable? 

Tax is payable on the whole of the profits of a trade. Payments for your own ‘wages’ are not deductible, but if for example you have a spouse that works in the business any wages paid to them are an allowable deduction, provided they are actually paid and are a reasonable reward for what is done. However, bear in mind that the payment of such wages is likely to lead to the need to set up a PAYE scheme and all of the monthly reporting requirements that this involves.

How will HMRC allocate profit to tax years?

The aim of the tax system is that over the lifetime of your business, the profits will be taxed in full and once only. But for the system to remain fair there are certain complications that you will have to deal with. 

Tax for a particular year is normally based on the profits of the twelve months to your accounting date in that tax year, but special rules apply in the opening and closing years of a business, or if you change your accounting year end date. 

How will HMRC collect tax?

Tax Returns

Tax returns will have to be submitted to HMRC for payments of tax. If you are unable to make the deadline for filing your tax return you could incur penalties.   A paper tax return has to be submitted by 31 October after the end of each tax year, but if you file online, you have a further three months in which to submit the return as the deadline is then 31 January after the end of each tax year.

Payment of tax 

Payments on account of income tax and Class 4 national insurance contributions will be due on 31 January and 31 July each year.   You need to bear in mind that when you start in business, your first tax payment will not be due until 31 January after the end of the tax year in which your business starts, and will be an abnormally large payment as it will cover all the tax for the first year of trading, plus a payment on account of half of this amount as a payment on account of the following years tax.  In an extreme case this first payment can be as much as 22 months after the date the business starts.

Saving to pay your tax 

It is important to make sure that you make proper provision to ensure that you have available tax to pay for your income tax and your national insurance. Any interest on unpaid tax that is occurred is chargeable by HMRC and is not deductible from business profits.

Our tax team

At Moore (South) we have a dedicated tax team split between our five offices. Our tax team are able to provide you with the guidance necessary to help individuals who plan to go self employed prepare, not only to ensure they remain tax compliant but to also improve tax efficiencies.