Tax on freelancers: what tax do I need to pay?
If you’re freelancing, understanding your tax obligations is crucial. What taxes must you pay as a freelancer, and how do you calculate and submit them? This article covers tax on freelancers in the UK, providing essential information on Income Tax, National Insurance Contributions (NICs), Value Added Tax (VAT), as well as key deadlines and thresholds to keep you compliant.
Overview:
- Understanding freelance taxation
- How does freelance tax work?
- UK tax brackets for freelancers
- Registering as a freelancer with HMRC
- Allowable expenses and deductons for freelancers
- Balancing freelance work and traditional employment
- Understanding payslips for freelancers
- How to pay tax on freelance work
- Tax planning strategies for freelancers
- IR35 and off-payroll working rules
Understanding freelance taxation
The first step in your freelance tax journey is understanding how the UK tax system views you. In the eyes of HM Revenue and Customs (HMRC), freelancers are typically regarded as sole traders once they start working for themselves. This self-employment status comes with an obligation to pay Income Tax on your profits, and in some cases, register and pay Value Added Tax (VAT).
Understanding the changes in tax payments when transitioning from traditional employment to freelancing is essential. As a self-employed individual, managing your tax affairs becomes your responsibility. You’re responsible for reporting your income and paying the right amount of tax.
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How does freelance tax work?
As a freelancer, you’re likely to be working as a sole trader. This means you must declare your income to HMRC via self-assessment.
You may be liable for Income Tax and National Insurance Contributions based on your profits. If you’re part of a partnership, you and your partners must each declare your share of income through Self-Assessment. However, the partnership itself doesn’t have a separate tax bill.
Depending on your business structure, the tax rates for freelancers may differ. For instance, as a sole trader, your trading profits exceeding the Personal Allowance of £12,570 are subject to Income Tax.
The tax rates can range from 20% to 45% (or 48% in Scotland). Conversely, if you’re running a limited company, you’ll pay corporation tax at a rate between 19% and 25% on company profits. Additionally, you’ll pay Income Tax on your salary and any dividends you take from the business.
To steer clear of penalties and late payment charges from HMRC, it is fundamental to keep a record of deadlines and payment obligations.
Freelancers must register for Self-Assessment with HMRC to declare their income and expenses, calculate their tax liabilities, and make payments. If your annual turnover exceeds the VAT threshold of £85,000, you will need to register for VAT, which involves charging VAT on invoices and paying it to HMRC.
UK tax brackets for freelancers
Now that we’ve covered the basics of freelance taxation, it’s time to delve deeper into the tax brackets for freelancers in the UK. The tax brackets determine the Income Tax rates you pay.
In the following sections, we’ll break down the Income Tax, National Insurance Contributions (NICs), and Value Added Tax (VAT) that freelancers need to be aware of.
Income Tax for freelancers
The amount of Income Tax you pay as a freelancer depends on your taxable profits. Here are some key points to keep in mind:
- You can earn up to £12,570 before paying any Income Tax due to the tax-free Personal Allowance.
- If your profits exceed the Personal Allowance, you will start to pay Income Tax.
- The tax-free Personal Allowance is reduced for freelancers earning above £100,000, with the allowance reduced by £1 for every £2 of income over the threshold.
Income Tax is calculated based on a marginal rate system, where only income within each band is taxed at its specific rate. This means that the lower rate is preserved for income in the previous band. In England, Wales, and Northern Ireland, freelancers pay the basic rate of 20% on income over £12,570 and up to £50,270, with higher rates for income beyond these amounts.
In contrast, in Scotland, there are five tax rates ranging from 19% to 47%, with specific bands for different income levels.
National Insurance Contributions (NICs)
National Insurance Contributions (NICs) are another key aspect of freelance tax.
As a freelancer, you’re typically required to pay Class 2 and Class 4 NICs. Class 2 NICs are a flat-rate weekly payment due when your profits exceed the Lower Profits Limit, currently set at £12,570 for the 2023/24 tax year.
However, from 6th April 2024, freelancers with profits above £12,570 will no longer have to pay Class 2 NICs in order to receive state benefits. On the other hand, if your profits are below the Small Profits Threshold of £6,725, you can voluntarily pay Class 2 NICs to maintain eligibility for certain benefits.
Class 4 NICs are income-based contributions. For the 2023/24 tax year, these are payable at a rate of 9% on profits between the Lower Profits Limit of £12,570 and the Upper Profits Limit of £50,270 (from 6th April 2024, the rate will decrease to 8%). A 2% rate is applied to profits above the Upper-Profit Limit..
Value added tax (VAT)
For the 2023–2024 tax year, the VAT taxable threshold for freelancers is £85,000, but this is set to increase on 1st April 2024 to £90,000.
You must register for VAT if your total VAT taxable turnover for the last 12 months is over £85,000. Additionally, you must register if you expect it to exceed that threshold in the next 30 days.
The VAT rates for the tax years 2023/24 and 2024/25 are set at a standard rate of 20%, a reduced rate of 5%, and a zero rate for certain goods and services. After registering for VAT, you must submit VAT returns and make payments monthly or quarterly, depending on the scheme you choose.
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Registering as a freelancer with HMRC
Once you’ve decided to be a freelancer and understood your tax obligations, the next step is to register as a freelancer with HMRC. This is a significant step to embark on your freelance journey, as it helps maintain compliance with your tax obligations.
Let’s explore the process of registering with HMRC and the important deadlines you need to be aware of.
Self-Assessment registration
The process of registering with HMRC begins with registering for Self-Assessment. You need to apply for a Unique Taxpayer Reference (UTR) number by providing personal details such as:
- Your full name
- Phone number
- Email address
- Residence
- Date of birth
- National Insurance number
- The date you started as self-employed
- The type of work you do
You’ll also need to provide identification documents such as a photo ID and an address ID.
Once you have your UTR number, you’re ready to file your Self-Assessment tax return. You must register for Self Assessment if you expect to earn more than £1,000 in a tax year. If you lose your UTR number, don’t panic – you can retrieve it through previous tax documents or by contacting HMRC directly.
Filing deadlines
In terms of tax payments, meeting deadlines is of utmost importance. Here are some key deadlines to keep in mind:
- The deadline for sending a paper Self-Assessment tax return is 31st October.
- The online Self-Assessment tax return deadline is 31st January following the end of the relevant tax year.
- Freelancers are also required to make two main tax payments each year: the first payment is due by 31st January and the second by 31st July. These may include a payment on account and the settlement of any outstanding tax.
It’s important to note that missing the registration deadline or tax payments as a freelancer results in penalties and interest charges.
However, if you find yourself unable to meet your tax obligations on time due to financial difficulties, HMRC allows for payment plans to be arranged under certain conditions.
Allowable expenses and deductions for freelancers
Being self-employed comes with the advantage of claiming a variety of business expenses to minimise your tax liability. These allowable expenses can include:
- Office costs
- Travel
- Marketing costs
- Professional fees
Let’s explore these deductions in detail.
Business expenses
Business expenses are one of the most effective ways to reduce your tax bill as a freelancer. These are costs you incur while running your business. Deductible expenses can include:
- Professional insurance
- Office costs
- Travel expenses
- Staff costs
- Costs for stock or materials
- Financial costs
- Advertising expenses
- Training expenses
- Software subscriptions
However, it’s important to note that not all business expenses are deductible. For instance, private purchases and clothing expenses are typically only deductible for uniforms. Also, only the business portion of an item that is used for both personal and business reasons can be claimed as a business expense.
Working from home deductions
Being a freelancer often means having the flexibility to work from home. If you do, you may be eligible to deduct a portion of expenses like from your taxes:
- Heating
- Electricity
- Council Tax
- Mortgage interest or rent
- Internet and telephone use
However, you must use a reasonable method to allocate home office costs appropriately, such as by the number of rooms used for business or the proportion of time spent working from home.
Depreciation and capital allowances
Lastly, let’s navigate through the concepts of depreciation and capital allowances.
These are ways to account for the wear and tear on your business assets over time, such as equipment, machinery, or vehicles. While HMRC doesn’t allow the deduction of depreciation, it applies specified rates of annual deduction called capital allowances to certain asset classes.
This means you can claim the full cost of certain business equipment – a great way to reduce your taxable profits!
Balancing freelance work and traditional employment
While freelancing is a full-time pursuit for some, others consider it an additional engagement alongside their regular employment. If you’re juggling both, you’ll need to balance your tax responsibilities for both income sources.
In the following sections, we’ll discuss how to report income from both sources and manage your tax and National Insurance Contributions.
Reporting income from both sources
The first step in managing your tax obligations when balancing freelance work and traditional employment is to report your income from both sources. Here are the steps to follow:
- Consolidate all your earnings, including your wages and freelance profits.
- Report your consolidated income on a Self-Assessment tax return for accurate tax reporting.
- Calculate the total tax amount by summing the income from wages and freelance work, applying the Personal Allowance, and considering the threshold for reporting freelance income without tax.
One important point to remember is that you need to deduct any tax already paid through your employer’s PAYE system from your total tax liability on the Self-Assessment tax return. This ensures you’re not paying tax twice on the same income.
Also, remember that freelancers completing a Self-Assessment must include all income sources, such as:
- Self-employment
- Employment
- Rental properties
- Investments
Along with details about income and expenses for each.
Paying taxes and National Insurance Contributions
In addition to Income Tax, balancing freelance work and traditional employment also involves managing National Insurance Contributions (NICs).
The amount and type of NICs you pay will depend on your employment status. For most freelancers, National Insurance Contributions (NICs) are based on self-employed profits, which could necessitate Class 2 and Class 4 NIC payments (although Class 2 NICs will no longer apply starting from 1st April 2024).
But if you’re also traditionally employed, you’ll pay Income Tax and Class 1 NICs through your employer’s payroll as well as on your self-employed income.
Understanding payslips for freelancers
Unlike a regular job, you may not receive a traditional payslip as a freelancer. However, creating a payslip for yourself is a smart move as it can help track your earnings and serve as proof of income, which can be handy when applying for loans or mortgages.
Let’s explore the importance of payslips for freelancers and how you can generate your own.
Why do freelancers need payslips?
Why should freelancers have payslips? Primarily, payslips assist in monitoring your earnings and expenses, crucial for precise income reporting and claiming tax deductions. Payslips also enhance your credibility and show that you follow sound financial practices.
Apart from these, payslips can also strengthen your case when applying for loans or mortgages by showcasing consistent earnings.
What should be included in a freelancer’s payslip?
A freelancer’s payslip should include various details that reflect your earnings and deductions. At a minimum, it should contain:
- Personal details
- The period covered by the payment
- The amount of money earned for that specific timeframe
- A breakdown of any deductions such as taxes and social security contributions.
Furthermore, detailed deductions on a payslip, such as taxes and social security contributions, help calculate the net pay accurately. It’s also crucial to reflect any variable income you receive, such as from different projects or clients, to accurately represent your financial situation. By including these details, you’ll have a comprehensive record of your earnings and deductions, which will be extremely helpful come tax time.
How to generate a self-employed payslip
Creating a self-employed payslip is a straightforward process. You can generate one by including the following information:
- Your name
- Your address
- Pay period dates
- Payment date
- Gross earnings
- Applicable taxes or deductions
- Net earnings
Remember, accuracy is crucial when generating a self-employed payslip; all calculations should align with any invoices or contracts related to the work performed.
For convenience and accuracy, you can use online tools and accounting software designed for freelancers. These can help create professional-looking payslips with necessary customisation options. Remember to regularly update your payslips, ideally monthly, to maintain an accurate record of your income and taxes throughout the year.
How to pay tax on freelance work
Paying Income Tax involves a few steps, and it’s crucial to get it right to avoid penalties and ensure you’re paying the correct amount. Let’s walk through the process of paying tax on freelance work.
You must register for Self-Assessment if your taxable income is more than £1,000 in a tax year. Following registration, you’re required to complete and file a Self-Assessment tax return every year, along with a supplementary tax return page SA103. In this return, you’ll declare your income and expenses, calculate your tax liability, and pay any tax due. If you’re also traditionally employed, you’ll have your total NICs calculated when you complete your Self-Assessment tax return.
Paying your tax isn’t just a one-time thing – it’s an ongoing responsibility you’ll have throughout the year. HMRC requires you to make two main tax payments each year: the first payment is due by 31st January and the second by 31st July. These may include a payment on account and the settlement of any outstanding tax. It’s also important to choose a payment method that allows HMRC to receive the payment by the deadline, considering some methods take longer than others.
How to reduce Income Tax if you’re self-employed
Even though tax payment is an integral part of freelancing, there are lawful methods to decrease the amount you owe. By using tax-efficient strategies, you can lower your overall tax liability and keep more of your hard-earned money. Let’s look at some methods to reduce Income Tax if you’re self-employed.
One of the most effective ways to reduce your Income Tax is to claim all allowable business expenses. These are costs you incur while running your business and can range from:
- Professional insurance
- Office costs
- Travel expenses
- Training costs
Remember, only the business portion of an item that is used for both personal and business reasons can be claimed as a business expense.
Another strategy to lower your taxable income is to make contributions to a retirement plan like a SEP IRA or a Solo 401(k). These contributions provide tax deferral benefits and lower your current year’s taxable income.
You can also get tax relief on charitable donations made using Gift Aid, including tax relief on gifts of land, property, or shares to charity.
Tax planning strategies for freelancers
Effective management of your freelance business entails tax planning. By taking a proactive approach to your taxes, you can optimise your tax liability and avoid any nasty surprises come tax time.
In this section, we’ll discuss some key tax planning strategies for freelancers.
Choosing the right business structure
Selecting the appropriate business structure is a pivotal tax planning approach. The way you set up your business can have a significant impact on your tax obligations. Freelancers in the UK can choose to set up their business as a sole trader, partnership, or limited company, each option having distinct tax implications.
Sole traders enjoy simplicity in tax reporting and lower setup costs, while limited companies can offer significant tax benefits such as reduced Income Tax and NICs through tax-efficient salary and dividend combinations.
Record-keeping and accounting
Proper record-keeping and accounting are vital for effective tax planning. Accurate records help you track your income and expenses, ensuring you claim all allowable deductions and accurately report your income.
This is crucial for freelancers to comply with tax rules and calculate exact tax payments. Using digital accounting software or working with a professional accountant can help you manage your records effectively and identify additional tax deductions and credits.
IR35 and off-payroll working rules
While we have addressed the primary elements of freelance tax, there remains an area that freelancers need to consider – the IR35 and off-payroll working rules. These rules target tax avoidance by ensuring that freelancers, who would be considered employees if they provided services directly, pay similar taxes to employees.
Let’s explore how these rules impact freelancers.
Understanding IR35
IR35 affects freelancers who may be deemed as ‘disguised employees’, working in the same role as they would as a payrolled employee but benefiting from lower taxation as a ‘limited company’. The client’s responsibility to assess a freelancer’s IR35 status may include reviewing the contract and comparing the relationship to that of payrolled employees. Clients may use online tools like HMRC’s Check Employment Status for Tax (CEST) or an independent assessment service to determine IR35 status.
If deemed inside IR35, freelancers may be deemed employees for tax purposes, and clients might alter contracts or work arrangements to comply with the legislation. Freelancers can appeal an IR35 status determination they disagree with through HMRC’s ‘Alternative Dispute Resolution’ service or take it to an IR35 tribunal. However, if freelancers have a genuine contractual relationship with clients, the crackdown on IR35 may not affect them as the legislation is subjective.
Determining employment status
Determining your employment status under IR35 can be complex. The legislation distinguishes between a contract of service (employment) and a contract for services (self-employment), which is pivotal in determining tax liabilities.
Factors such as personal service, degree of control, and lack of mutuality of obligations are key in assessing IR35 status.
To support a determination of being outside IR35, contracts should explicitly show the absence of mutual obligations, both for offering ongoing work and within the current engagement.
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Summary
Embarking on a freelance journey can be both exciting and daunting, especially when it comes to understanding and managing your tax obligations. But with the right knowledge and guidance, you can confidently navigate freelance tax.
From understanding the basics of tax brackets and registering with HMRC to reducing your Income Tax through allowable expenses and choosing the right business structure, this guide has covered the key aspects you need to know. Remember, staying organised, keeping accurate records, and planning ahead can make your tax journey a whole lot smoother.
FAQs
As a freelancer, you’ll pay personal Income Tax on your trading profits at a rate of up to 45%, or 47% in Scotland if you are operating as a sole trader. If you operate as a limited company, the company will pay a corporation tax of 19% on profits, and you also have to pay tax on dividends extracted from the company. This structure determines the tax responsibilities for freelancers.
Yes, if your side hustle qualifies as a trading activity and generates a profit above your tax allowances, it will be subject to taxation on the earnings. It’s important to be aware that making a profit from a side hustle will likely result in taxable income.
To register as a freelancer with HMRC, you’ll need to register for Self-Assessment and apply for a Unique Taxpayer Reference (UTR) number if you expect to earn over £1,000 in a tax year.
As a freelancer, you can claim various business expenses such as professional insurance, office costs, travel, staff costs, stock or materials, financial costs, advertising, training, and software subscriptions. This can help reduce your taxable income and save you money.
After you register for Self-Assessment, you’ll need to file a Self-Assessment tax return and pay any tax owed on your income.
HMRC employs various methods to detect undeclared income such as data matching, where they cross-reference information from different sources like banks, employers, and property transactions to identify discrepancies. They also use advanced analytics and risk profiling to target individuals or businesses with suspicious financial activities. Additionally, HMRC conducts random audits and investigations based on tips, industry trends, or past non-compliance.
As a freelancer, you may be eligible to claim back Value Added Tax (VAT) on business-related expenses if you are registered for VAT and the purchases are directly related to your business activities. To reclaim VAT, your purchases must be for goods or services used for business purposes and not for personal use. This typically includes expenses such as office supplies, equipment, and professional services.
