Navigating UK Taxes as a Freelancer: A Short Guide

As a freelancer, you have more control over your income, hours, and the type of work you take on. Whether freelancing is your full-time job or a way of earning extra money, it can offer considerable freedom and flexibility.

But as a freelancer, you also have more responsibility. As well as running and marketing your business, you need to make sure you are compliant with tax rules.

Tax on Trading Profits
Many people set up their businesses on a sole trader or partnership basis. This is a fairly simple structure which is easy to administer.

When you are self-employed, any profit you make from the business is added to your taxable income. You will then pay tax on this income at your marginal rate. You can find out the rates of tax here. The first £12,570 of income is free of tax.

If you freelance in addition to your main job, it’s likely that your tax-free personal allowance will be used up via your employer. This means you will pay the full rate of tax on your trading profits.

If you are self-employed, you will need to complete a tax return. You can do this yourself or appoint an accountant. You need to calculate your profits and work out the tax you need to pay.

Most self-employed people make two tax payments each year. This includes:

• By 31st January – a payment on account for the current tax year, as well as full settlement of any outstanding tax for the previous tax year.
• By 31st July – a second payment on account.

If you are also employed, you may have the option of paying tax through your tax code. This can simplify things, although you will probably still need to make an adjustment at the end of the tax year.

National Insurance
Whether you are employed or self-employed, you need to pay National Insurance contributions to build up an entitlement to certain benefits, including the State Pension.

As a self-employed person, there are two types of National Insurance:

• Class 2 – this is a flat rate of £3.45 per week
• Class 4 – 9% of profits between £12,570 and £50,270 and 2% on profits above this

National Insurance is also paid through self-assessment.

If you don’t earn enough to pay National Insurance, you may wish to make voluntary (Class 3) contributions to make sure you will be entitled to the same benefits.

Expenses
You can claim expenses through your business which can help to reduce tax. You can claim for:

• Supplies and stock
• Costs relating to your business premises, including rent and utilities
• Insurance
• Office supplies
• Advertising
• Staffing costs
• Professional services such as accountancy
• Training
• Travel, including business mileage

You can also claim a portion of your household costs if you work from home.

If your costs are under £1,000 per year, you can claim a trading allowance rather than reporting each expense individually.

Your costs are deducted from your income to arrive at your net profit, which you pay tax on.

Setting Up a Limited Company
Once your business is established, or if you are entering into a contract, it might be a good idea to set up a limited company. This is a separate entity, which can offer some legal protection if anything goes wrong.

You have two options for taking an income from your company:

• Salary – this is taxed at the normal rates as mentioned above. It is paid before the business profits are declared. You will also need to pay employee and employer National Insurance if your salary is over the threshold.
• Dividends – these are taxed at different rates, and are taken from the declared company profits. You can earn up to £1,000 in dividends (in addition to your personal allowance) before paying tax. National Insurance doesn’t apply.

Most freelancers take their income as a combination of salary and dividends.

In addition, the company will pay corporation tax. The rate is between 19% and 25% depending on the levels of profit. The company can also claim expenses to reduce tax.

Company tax reporting is a bit more involved, and it’s likely that you will need an accountant. However, there are also more options to control and reduce your tax bill.

IR35
If you are working as a contractor for one client, you may be affected by the IR35 rules, particularly if you provide your services through an intermediary company.

The rules aim to reduce tax avoidance and ensure that if a contractor is functionally employed by a company, that they pay tax at the same rates as an employee.

It’s a good idea to seek tax advice to make sure you are complying with the rules and paying the correct rates of tax.

Pension Planning for Business Owners
Business owners can save significant tax by paying into a pension, as well as building up a pot for retirement.

If you are a sole trader, you can make personal pension contributions of up to £3,600 per year or the value of your trading profits for the year, whichever is higher. You pay 80% of the contribution yourself, and the remaining 20% is credited to your pension by HMRC. If you are a higher or additional rate taxpayer, you can claim additional tax relief through self assessment.

Limited companies can make tax-deductible pension contributions for their employees, including directors. This is not limited by earnings, but must be considered reasonable by the local inspector of taxes.

Personal and company contributions are further capped by the annual allowance, which is currently £60,000. However, if you have been a member of a pension scheme and have unused allowance from any of the previous three tax years, you may be able to carry this forward. If your spouse or children work in the business, you can also make pension contributions for them.

Pensions are a highly efficient way of taking profits from your business.

Tax can be a little more complicated if you are a freelancer, but you have considerably more control over your situation.

Please don’t hesitate to contact a member of the team to find out more about tax planning.