Trying to figure out how tax for self-employment works? In this guide, you’ll find an overview of self-employed tax including how they are calculated, sole trader tax brackets and how you’ll pay self-employed national insurance.
This guide relates to self-employed taxes. If you have a Limited Company you’ll be affected by different taxes, such as corporation tax and dividend tax.
Friendly Disclaimer: Whilst I am an accountant, I’m not your accountant. The information in this article is legally correct but it is for guidance and information purposes only. Everyone’s situation is different and unique so you’ll need to use your own best judgement when applying the advice that I give to your situation. If you are unsure or have a question be sure to contact a qualified professional because mistakes can result in penalties.
How Do Taxes for Self-Employment Work?
In summary, self-employed individuals in the UK pay income tax as well as class 2 and class 4 national insurance on their business profits. It is their responsibility to declare their self-employment income to HMRC on a tax return, which they will be issued with once they have successfully registered for self-assessment.
The reason you need to declare your income and pay tax is that when you’re self-employed, in most cases**, the money that is paid to you has no tax deducted from you (unlike if you’ve ever received a payslip). But these types of earnings are usually considered taxable.
**The main exception to the above is those working in the construction industry who pay CIS tax and follow a special set of rules.
When to Register for Self-Employment Tax
You need to register with HMRC by the 5th of October following the end of the tax year you started working for yourself.
The UK tax year runs from 6 April to 5 April each year. So if you earned taxable income during the 2022-23 tax year (between 6 April 2022 to 5 April 2023), you’ll need to register by 5 October 2023.
What is Self Assessment?
Self-assessment is the process created by HMRC that allows anyone who earns untaxed income to declare it to the government and pay any tax due. The form you need to use is a tax return.
What is a Tax Return?
A tax return is a form issued by HMRC. It contains lots of different sections and boxes that you need to fill in to declare your self-employment income. Once completed, HMRC will then calculate how much tax you owe ready for you to pay them.
Not sure when you need to file your first return? Check when you need to file your first tax return in this guide.
Important Dates for Self-Employed Taxes
You need to fill in your tax return by the 31 January each year summarising all your earnings for the previous tax year. So a tax return due by 31 January 2023 would contain all your earnings between 6 April 2021 to 5 April 2022.
In addition to filling in your return, you’ll also need to pay self-employment taxes twice a year by 31 January and 31 July.
UK Self-Employed Tax Brackets
Once your income goes over the £1,000 tax-free threshold, you’ll need to pay income tax, class 2 and class 4 national insurance on your business profits. Profit means all your income minus expenses you can claim as a tax deduction.
Income Tax Rates for the Self-Employed
Once your income goes over the £1,000 tax-free threshold, you’ll start paying income tax. The income tax rates for the 2022-23 tax year are:
- £0 to £12,570 0% (personal allowance)
- £12,571 to £50,270 20% (basic rate)
- £50,271 to £150,000 40% (higher rate)
- Over £150,000 45% (additional rate)
The amount of income you pay is based on all your income during the tax year. So if you are employed and self-employed, you’ll income tax bracket you’ll fall into will be based on your combined income. Read this guide to find out more about tax when you’re employed and self-employed and what to look out for.
National Insurance Rates for the Self-Employed
Being self-employed, you’ll also pay National Insurance on your business profits. Again, you won’t pay any if you earn up to the tax-free thresholds. Here are the National Insurance rates for the 2022/2023 tax year:
- Class 2 National Insurance £3.15 per week on profits over £6,725 per year
- Class 4 National Insurance 9.73% on profits between £11,909 and £50,270 and 2.73% thereafter.
An Example of How to Calculate Self-Employment Tax
Your business profits for the tax year 2022-23 are £20,000. You have no other forms of income for the tax year and this is your first year of self-employment. Your tax bill will be £2,437.05 calculated as:
- Income tax £1,486 (£20,000 – £12,570)
- Class 2 national insurance £163.80 (£3.15 x 52 weeks)
- Class 4 national insurance £787.25 (£20,000 – £11,909 x 9.73%)
In addition, as your tax bill is over £1,000 for 2022-23 you’ll be required to make an advance payment towards your next years tax bill. This is known as a payment on account and is calculated as 50% of the current years tax bill £1,218.53 (2,437.05 x 50%).
The total payment required £3,655.58 by 31 January 2024, along with completing your tax return online by the same date.
Do You Have to Pay Tax in Your First Year of Self-Employment?
There is no tax exemption because it is your first year of self-employment. Once your income goes over the £1,000 tax-free threshold, you’ll need to register with HMRC and start paying taxes and national insurance depending on how much money you are making.
Depending on when you start self-employment, it can be up to 18 months before you have to file a tax return and pay any tax you owe. Given the length of time it is a good idea to set money aside by budgeting for your tax bill.
Watch out as well. If this is your first year of self-employment your tax bill could be 50% higher because you’ll need to pay a contribution towards your next tax bill.
How You Pay National Insurance When You’re Self-Employed
National Insurance is a type of tax where UK workers (whether employed or self-employed) pay into a ‘pot’. This will then entitle them to claim certain state benefits such as:
- Unemployment benefits
- Statutory sick pay
- Maternity allowance
- State pension
When you are self-employed you need to pay two types of National Insurance:
- Class 2 National Insurance
- Class 4 National Insurance
The amount of each of these you pay is based on your self-employment profits only; you don’t need to include any other income when working out how much you owe. If you are employed in a job, you’ll still need to pay Class 1 National insurance on your employment earnings. However, your employer will calculate this for you.
What Happens if You Don’t Pay National Insurance When You’re Self-Employed
Despite not paying Class 2 National Insurance, some people choose to pay it voluntarily. This is because it keeps their NI records up to date. It also protects their ability to claim state benefits like Maternity Allowance and the state pension.
What Happens if You Don’t Pay Tax?
If you don’t pay self-employment taxes because your earnings are below the personal allowance or the trading income allowance, then there is nothing to worry about. However, this is only if you register and declare your earnings to HMRC.
HMRC have ways and means of finding things out. Therefore, if you don’t pay self-employment taxes but know that you should have registered with HMRC as self-employed, then you can face penalties for failing to register, file tax returns and not paying taxes. Once HMRC does hit you with penalties and interest charges, they’ll offer little leeway when it comes to paying what you owe. In some cases, once they investigate, they can declare you bankrupt and in the most extreme cases, you can go to prison.
What About VAT?
VAT is a tax charged to consumers on most goods and services supplied in the UK. It stands for Value Added Tax and the current standard rate is 20%. There are three different types of VAT rates. These are applied depending on the goods or service being sold.
|Rate||Goods & Services Rate Applies to:|
|Standard Rate 20%||Most goods and services|
|Reduced Rate 5%||Electricity, gas, carrycots, children’s car seats, maternity pads, sanitary protection products, nicotine patches|
|Zero Rate (0%)||Books, newspapers, children’s clothing, certain food & drink, household water|
If your business’ taxable turnover exceeds the VAT threshold of £85,000, then you are legally required by HMRC to register for VAT. If that applies to you then once registered you must:
- Charge VAT at the correct rate on everything you sell;
- Deduct VAT you paid to your suppliers from the VAT you charged your customers;
- Pay the difference on VAT paid and received to HMRC, normally quarterly;
- Submit VAT returns using an HMRC approved bookkeeping software;
- Keep VAT receipts.
Being registered for VAT carries more administration and reporting to HMRC. That said, some businesses choose to voluntarily register for VAT because it brings tax and cash flow benefits.
How To Avoid Paying Tax When Self-Employed
The easiest way to avoid paying tax is to claim back all the allowable expenses you are legally entitled to. It is the most overlooked aspect because people don’t stay on top of their bookkeeping, claiming expenses and keeping receipts. So, make sure you set up a bookkeeping system that you keep up-to-date because it is the easiest way to reduce your tax bill.
There are also other income tax reliefs and allowances that you may be entitled to that will help to reduce the amount of tax you have to pay including:
Key Takeaways for How the Self-employment Tax Works
- When you’re self-employed you’ll pay income tax as well as Class 2 and Class 4 National Insurance. However, the amount you’ll pay depends on how much you earn above the tax-free thresholds;
- You can deduct business expenses from your income which helps to reduce your tax bill, but not all expenses are allowable;
- You’ll need to report your earnings on a tax return each year. If you do that online, HMRC will calculate your tax automatically.