I know that self-employed taxes can be a complicated subject, but they are an unavoidable part of working for yourself. What self-employment tax do you pay? When and how do you report your earnings? And, how do you (legally) reduce how much you pay to HMRC? If you aren’t sure where to start when it comes to taxes and you’re worried the tax-man is lurking around the corner, then this guide is for you.
I’ll answer some of the common questions that I see online. They’re also the questions most asked in my previous life as a Chartered Accountant by people who have set up a business. It’ll take away the worry that you’re missing out on tax allowances and show you the deadlines you need to know. I know it can be complicated if taxes are new to you so don’t worry if you don’t understand it all at once. Simply, bookmark this page and come back to it when you come across each term in context to refer back and understand it better.
Updated 14 March 2022
Table of contents
- 1. How Do The Self-Employed Pay Tax?
- 2. How Much Can You Earn as Self-Employed Before Paying Tax
- 3. Do You Have to Pay Tax in Your First Year of Self Employment?
- 4. Income Tax When You’re Self-Employed
- 5. National Insurance When You’re Self-Employed
- 6. When Do You Pay Self-Employed Taxes?
- 7. Reporting Your Self-Employment Earnings to HMRC
- 8. What Happens if You Don’t Pay Tax?
- 9. What About VAT?
- 10. How To Avoid Paying Tax When Self-Employed
- Key Takeaways for How the Self-employment Tax Works
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.
1. How Do The Self-Employed Pay Tax?
Here’s a quick summary of how taxes and National Insurance work for the self-employed. I’ll go into more detail about each part in this guide.
The self-employed are responsible for managing their own taxes. In contrast, when you work for an employer, they give you a payslip with all your taxes deducted. However, every time you get paid in your business or by a client, the money you receive has no tax deducted from it. This means it’s your responsibility for working out how much tax and National Insurance you need to pay from your earnings.
When you’re registered as self-employed with HMRC you’ll have a tax bill to pay twice a year (by 31 January and 31 July). In addition, you’re required to fill out a tax return once a year to declare your earnings (by 31 January).
2. How Much Can You Earn as Self-Employed Before Paying Tax
You can actually earn £1,000 tax-free by utilising the trading income allowance during the tax year. It’s a little tax break that means if you get paid income (not profit) of £1,000, you don’t need to let HMRC know about it. You also won’t need to register with them as self-employed.
Once your income goes over £1,000, you can then earn up to £12,570 in profit for the tax year 2022/2023. This is without paying tax because of the personal allowance – the amount that everyone in the UK is entitled to earn tax-free. Even if you have no tax to pay, you must still register as self-employed and let HMRC know about your earnings. Once your profits go over the tax-free amount, you’ll start to pay income tax as follows:
- £12,571 to £50,270 20% (basic rate)
- £50,271 to £150,000 40% (higher rate)
- Over £150,000 45% (additional rate)
What about other forms of income? For example, you are employed and self-employed then you’ll pay income tax based on all your combined earnings – read this guide to find out more.
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 10.25% on profits between £9,880 and £50,270 and 3.25% thereafter.
Despite not having to pay 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.
3. Do You Have to Pay Tax in Your First Year of Self Employment?
The more you earn, the more tax you pay. There is no exemption because it is your first year working for yourself. That said, if you have an income (not profit) from your business of £1,000 or less you could take advantage of the trading income allowance. This implies your income is tax-free and doesn’t need to be reported to HMRC.
Depending on when you started self-employment, it can be up to 18 months before you have to pay any tax over to HMRC. However, it’s a good idea to put your tax money aside so you don’t spend it and then get hit with a large tax bill! Opening a separate business bank account will help – take a look at Starling which is free for one month.
You should also be mindful that in your first year of self-employment, your first tax bill will be 50% higher. That’s because, depending on your profits, you will probably need to pay a 50% contribution towards your next years’ tax bill. This is known as a payment on account.
4. Income Tax When You’re Self-Employed
That’s why self-employment is so attractive because you get to deduct business expenses before paying tax. This is different to when you work for someone and you have access to very limited deductions.
You’ll pay income tax at the same rate as everyone else, so for the 2022/2023 tax year you can earn up to £12,570 tax-free. After this, you’ll pay income tax at 20% on your earnings up to £50,270 and 40% over that amount. This is until you reach £150,000 and have to pay 45%.
|Personal allowance 0%||£12,570||£12,570|
|Basic rate 20%||£12,570 to £50,270||£12,570 to £50,270|
|Higher rate 40%||£50,271 to £150,000||£50,271 to £150,000|
|Additional rate 45%||over £150,000||over £150,000|
You are self-employed and during the tax year 2022/2023 after deducting allowable expenses, you make a profit of £40,000. You’ll need to pay income tax of £5,486 which is calculated as:
- 0% on the first £12,570 profit
- 20% on the remaining £27,430 profit
You are employed and self-employed, so have two forms of income. During the tax year 2022/2023 you earned:
- £40,000 from your employment
- £12,000 profit through self-employment
That means your combined income is £52,000. Your income tax bill for 2022/2023 would be £8,232.20 which is calculated as:
- 0% on the first £12,570 income;
- 20% on the next £37,699 income;
- 40% on the last £1,731 income.
In addition to income tax, you’ll need to pay two types of National Insurance when you’re self-employed – Class 2 and Class 4. Again, the more you earn the more you’ll pay.
|Class 2 National Insurance||£3.15 per week on profits over £6,725 per year||£3.05 per week on profits over £6,475 per year|
|Class 4 National Insurance||10.25% on profits between £9,880 and £50,270|
3.25% on profits over £50,270
|9% on profits between £9,658 and £50,270
2% on profits over £50,270
5. 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:
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.
You’ll pay Class 2 National Insurance of £3.15 per week when your profits go over £6,725 per year; and Class 4 at 10.25% on profits between £9,880 and £50,270; and 3.25% thereafter.
5.1 Class 2 National Insurance
You’ll pay self-employed Class 2 National Insurance when your business profits reach a certain level (known as the small profits threshold). Class 2 National Insurance is paid at a fixed amount and the current rates are:
|Small profits threshold – no NICs below this threshold||£6,725||£6,515|
|Class 2 National Insurance||£3.15 per week||£3.05 per week|
You are self-employed and during the tax year 2022/2023 and you make a profit of £40,000. Your profits exceed the small profits threshold of £6,725 so you’ll need to pay Class 2 National Insurance of £163.80 (£3.15 x 52 weeks).
If you go self-employed part way through a tax year, the amount you’ll pay will be pro-rated to match the number of weeks you were in business.
5.2 Class 4 National Insurance
You’ll pay self-employed Class 4 National Insurance when your business profits again reach a certain level. This is called the small profits threshold. Below this level, you’ll be exempt from paying class 4 National Insurance. The current rates are:
|Small profits threshold – no NICs below this threshold||£9,880||£9,658|
|Class 4 National Insurance 10.25%||£50,270||£50,270|
|Class 4 National Insurance 3.25%||over £50,270||over £50,270|
You are self-employed and during the tax year 2022/2023 you make a profit of £40,000. You’re profits exceed the small profits threshold of £9,880. You’ll pay Class 4 National Insurance of £3,087.30 which is worked out as (£40,000 – £9,880) x 10.25%.
6. When Do You Pay Self-Employed Taxes?
Self-employment taxes are due twice a year by the 31 January and 31 July. It’s really important to budget for your tax bill so you have the money ready. One of the easiest ways to do that is to tuck money away either monthly or every time you get paid at your highest rate of tax. That means it’s important you stay on top of your bookkeeping so you know how much tax you need to save.
Your payment on 31 July and part of the tax you’ll pay on 31 January, is called a payment on account. It’s a contribution towards your next years tax bill, calculated each time as 50% of your current tax bill. That way, by the time you reach the following January, you’ll have already paid a portion of your bill, but you’ll make a new contribution.
You should also be mindful that in your first year of self-employment, your first tax bill in January will be 50% higher. You’ll be paying tax on money you haven’t even earned yet.
7. Reporting Your Self-Employment Earnings to HMRC
Once a year, you’ll need to report your earnings to HMRC using a tax return. This is referred to as ‘self assessment‘.
You’ll need to file your tax return by 31 January each year and most likely you’ll do this online. You can fill out a paper version but you’ll need to get it in sooner, in October instead of January. Plus, if you do it online, HMRC works out your tax for you straight away. One tax return covers one tax year. So, your return due by 31 January 2021, will cover your income and expenses for the tax year 2019/2020.
8. 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 you very 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.
9. 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|
- 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.
10. 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.
- Tax When You’re Employed and Self-Employed
- HMRC Payments on Account Explained
- How to Claim Self Employed Expenses
- HMRC Self Assessment Explained
Taxes are changing! From April 2024 sole traders will need to report their earnings and pay tax on a quarterly basis. This is known as Making Tax Digital, which you can read more about in this guide to help you get prepared.