If you’re here, then chances are you’ve already started your own business or, like me, you are going from hobby to business owner and are keen to get on top of your financial admin.

Whatever your situation, going self-employed is an exciting time and you’re no doubt getting to grips with a lot of new concepts, terms and skills.

As a Chartered Accountant self-employment taxes was the one topic I had a head start on as a business owner and I knew that handling my taxes was fundamental to me building a successful small business.

I put this guide together to help introduce other small business owners to the basics of tax and national insurance.

Don’t worry if you don’t understand it all at once.

Keep the guide handy, and when you come across each term in context, you can refer back to it so you understand it better.

I only cover self-employment tax in this guide.

Friendly Disclaimer: The information contained in this article is for guidance and information purposes only. It should not be relied upon as professional accounting, tax and legal advice. For specific advice relevant to your own situation, always contact a professional.

What Tax Do You Pay When You’re Self-Employed?

There are 3 types of taxes that you’ll need to pay:

  1. Income Tax
  2. Class 2 National Insurance
  3. Class 4 National Insurance

The amount of each of these you pay depends on how much profit your business makes during one complete tax year, after deducting any allowances you are entitled to.

Confused? Here are the basic terms I recommend you get to grips with:

Tax Year

The tax year in the UK runs from 6 April to 5 April every year.

Business Profit

HMRC defines profit as:

“All your business income minus your allowable business expenses”

That means everything you get paid less the business expenses HMRC permit you to deduct.

Business Income

Everything you get paid from all your different sources of income like your clients, customers or affiliate schemes.

How to Calculate Your Business Income

Allowable Business Expenses

Generally, most of the things you pay for as part of running your business are allowable – that means they you can include them when it comes to working out your taxes.

But there are certain expenses you can’t claim even though you may have paid for them as part of running your business.

That’s things like:

  • Fines and penalties
  • Personal expenses
  • Certain training courses
  • Entertainment
  • The money you pay yourself

I’ve written a guide dedicated to allowable business expenses including advice on what records you need to keep and what happens when you use something for work and personal reasons.

Personal Allowance

Everyone in the UK is entitled to earn a set amount tax-free every tax year. The amount changes at the start of every tax year, so you should keep an eye on changes especially if you regularly budget for your tax bill.

The personal allowance for 2019/2020 is £12,500 and was £11,850 for 2018/2019.

Personal Allowance Restriction

Your personal allowance is restricted once you earn more than £100,000.

Once you earn over £100,000 your personal allowance begins to get taken back at a rate of £1 for £2 you earn, until your income reaches £122,000 and it is clawed back completely.

That means anyone earning over £122,000 does not receive any personal allowance.

So how much tax do you pay? Let’s look at each of the 3 different taxes in turn.

How Much Tax Do You Pay If You’re Self-Employed?

When you are self-employed you start paying tax on your business profits over and above the personal allowance.

The more you earn, the more income tax you’ll pay.

If you have more than one form of income you’ll need to add this to your self-employment income before working out your tax bill.

Here are the current income tax rates:

 2019/20202018/2019
Personal allowance 0%£12,500£11,851
Basic rate 20%£12,501 to £50,000£11,851 to £46,350
Higher rate 40%£50,001 and £150,000£46,351 to £150,000
Additional rate 45%over £150,000over £150,000

Example 1

You are self-employed and during the tax year 2019/2020 you make a profit of £40,000.

You’ll need to pay tax of £5,500 which is calculated as:

  • 0% on the first £12,500 profit
  • 20% on the remaining £27,500 profit

Example 2

You are employed and self-employed, so have two forms of income. During tax year 2019/2020 you earned:

  • £40,000 from your employment
  • £12,000 profit through self-employment

That means your combined income from both is £52,000.

Your income tax bill for 2019/2020 would be £8,300 which is calculated as:

  • 0% on the first £12,500 income;
  • 20% on the next £37,500 income;
  • 40% on the last £2,000 income.

How Much National Insurance Do You Pay If You’re Self-Employed?

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, which your employer will calculate for you.

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:

 2019/20202018/2019
Small profits threshold – no NICs below this threshold£6,365£6,205
Class 2 National Insurance£3.00 per week£2.95 per week

Example

You are self-employed and during the tax year 2019/2020 you make a profit of £40,000.

You’re profits exceed the small profits threshold of £6,365 so you’ll need to pay Class 2 national insurance of £156 (£3.00 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.

Class 2 National Insurance protects your ability to claim certain state benefits like maternity allowance and the state pension.

Failing to pay Class 2 national insurance means you may not be able to claim for state benefits or find yourself entitled to a reduced amount.

For this reason, many self-employed people choose to pay Class 2 National Insurance voluntarily.

Class 4 National Insurance

You’ll pay self-employed Class 4 national insurance when your business profits again reach a certain level (known as the small profits threshold).

The current Class 4 National Insurance rates are:

 2019/20202018/2019
Small profits threshold – no NICs below this threshold£8,632£8,424
Class 4 National Insurance 9%£50,000£46,350
Class 4 National Insurance 2%over £50,000over £46,350

Example

You are self-employed and during the tax year 2019/2020 you make a profit of £40,000.

You’re profits exceed the small profits threshold of £8,632. You’ll pay Class 4 national insurance of £2,823.12 which is worked out as (£40,000 – £8.632) x 9%.

How Do You Pay Tax and National Insurance When You’re Self-Employed?

First things first, you’ll need to be registered as self-employed so HMRC know to expect tax payments from you and can issue you with the details you need to make the payments.

If you haven’t done that, then read my guide on registering as self-employed which walks you through everything you need to do.

Once you are registered with HMRC you’ll need to:

  • Fill out a tax return form once a year, by 31 January, to tell HMRC about all your income and expenses;
  • Pay tax and national insurance twice a year on 31 January and 31 July (a payment on account, which is a contribution to your next years tax bill).

You can find out more about tax returns and payments on accounts in these posts:

What is a Self-Assessment Tax Return Form

A Beginners Guide to Payments on Account

Self-Employed Tax and National Insurance Calculator UK

Budgeting for your tax is essential to running your business and paying yourself.

There’s nothing more terrifying than getting hit with a huge unexpected tax bill and being faced with the prospect of fines from HMRC for paying your tax late.

If it is your first year of being in business, you’ll may end up paying tax twice because you’ll need to pay your first tax bill as well your contribution towards your next years tax bill.

Grab a copy of my self-employed tax calculator (2019/2020 version). It will help you estimate and budget for your tax bill, including your payment on account.

What Allowances and Reliefs are there to Reduce Your Tax Bill?

The easiest way to reduce your tax bill is by claiming all the business expenses you possibly can.

That’s why getting a rock solid bookkeeping system in place that helps you record every expense will pay dividends.

Other tax reliefs and allowances that you may be entitled to that will reduce your tax bill include:

If you want to find out more ways to reduce your tax bill, then read this post where I share my top 10 super simple ways you can save tax.

How Much Can You Earn Tax-Free When You’re Self Employed

You can earn an income of £1,000 tax-free without needing to tell HMRC. Once you earn more than this, you’ll need to register with HMRC, but you won’t begin to pay tax until you earn more than the personal allowance.

Example 1

You are self-employed and your business makes £30,000 profit during 2019/2020. You have no other income so you can earn £12,500 tax-free and you’ll need to pay tax on £17,500 (£30,000 less £12,500).

Example 2

You are employed and self-employed during the tax year 2019/2020. You earn £30,000 from your employment and £10,000 being self-employed.

You are only entitled to the personal allowance of £12,500 once. This will probably be given to you through your employment, as this is where your highest salary is. Every month when your employer pays you, they will deduct one month’s worth of your personal allowance from your salary before they work out your tax.

Your income from self-employment will not be tax-free as you have used all your personal allowance up against your employment salary.

Even if you have no tax to pay, you’ll still need to fill out a tax return and declare your earnings to HMRC.

Is Your First Year of Self-Employment Tax-Free?

No, the first year of self-employment is not tax-free. Often if someone is new to self-employment their earnings can be low or they have bought start-up materials that wipe out their business profits.

This means their personal allowance covers any income they have made or they have made a tax loss, so they have no tax to pay.

Even if you have no tax to pay, you’ll still need to fill out a tax return and declare your earnings to HMRC.

What Happens if you don’t Pay Self-Employment Taxes?

If you don’t pay self-employment taxes because your earnings are below the personal allowance, then there is nothing to worry about. As long as you register and declare your earnings to HMRC.

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.

What Happens if You don’t Pay National Insurance Contributions?

If you don’t pay national insurance contributions because your earnings are below the small profits threshold, then this is absolutely fine.

Not paying Class 2 national insurance however can have an impact on your ability to claim state benefits, so you may want to consider paying them voluntarily.

Wrapping Up

Taxes are an inevitable part of running a small business and the more money you earn the more you’ll have to pay – so you’ll never get away from them!

Taxes don’t need to be stressful, if you get prepared and understand exactly what you need to pay and when.

When you’re self-employed you’ll need to pay income tax as well as class 2 and class 4 national insurance.

It is your responsibility to work out how much tax you have to pay and fill out a self-assessment tax return once a year to let HMRC know how much your earnings are.

Don’t forget you may also need to make a payment on account on 31 July each year (a contribution towards your next years tax bill), so make sure you budget for that too!

Updated 5 October 2019