Tax Rules For The Self Employed
After you become self-employed, the tax rules are different to those that applied when you were an employee.
Instead of tax and national insurance being deducted from your earnings at source, you should prepare to receive a bill at some time in the future.
This can be a nasty shock if you haven’t put enough money aside.
We will give you as much warning as possible of the likely amount of tax payments becoming due , but it is not easy to do this during the first year of your new business, or if you do not keep your records up-to-date.
What Do You Pay Tax On ?
The starting point for working out your taxable profits is a profit and loss account.
You can claim deductions from your business income for most expenses incurred for the purpose of your trade.
If you buy equipment for your business, you can generally deduct the full cost (up to a maximum of £200,000 per year). There are different rules for the cost of buying cars, and you can only deduct a proportion of the cost each year.
If you take business stock for your own use, the sale must be included in the accounts at market value, and not at the cost to you.
Tax is payable on the whole of the profits of a trade, and so payments for your own ‘wages’ (known as drawings) are not deductible.
Allocating Profit To Different Tax Years
The aim of the self assessment system is that over the lifetime of a business the profits will be taxed in full, once, and once only.
But to do this, there are a few complications to deal with.
The general rule is that the tax for a particular tax year is based on the profits of the twelve months to your accounting date in that tax year.
For example, the tax for 2018/19 could be based on accounts for a year ending on various dates ranging from 6 April 2018 to 5 April 2019. This system offers means that you get more time for the tax to be worked out if your accounts end early in the tax year, which is why 30 April is a popular year-end for self-employed people.
However, it's easy to build up a large tax liability using this date so it's often 5 April that is used instead, as it's simple to understand and allocate in line with the tax year.
Additionally using any other date rather than 5 April potentially gives rise to a period being taxed twice from the first profit and loss figures. This period that is taxed twice is treated as an 'overlap period' and the profits that have been double taxed are available to offset against the final period of trading of the business, although this may be many years down the line.
Collecting The Tax Due
Tax returns covering income for each year ending 5 April have to be submitted to HMRC by the ‘filing date’ which is 31 January following.
Your tax return will include a self assessment of your tax owed.
There are automatic penalties for late filing of tax returns so you cannot delay informing HMRC in the hope of delaying paying the tax.
Paying Tax Due
Payments on account of income tax and Class 4 national insurance contributions (NICs) are normally due each year on 31 January and 31 July.
After your first tax return has been submitted you will generally need to make interim payments on account based on one half of the total liability for the previous year. You can reduce these payments on account if you believe the interim payments will be too high.
Any underpayment left after your interim payments are made is collected on 31 January each year, when the entire cycle begins again.
Interest and penalties are charged for late payments.