Small business and tax blog

“I have a full-time job, but I have started doing some self-employed work in my spare time. What do I need to do about my taxes, how much tax will I have to pay, and when?”

What to do?

First of all, within 3 months of starting the self-employed work, you should register with the tax office as a new business. This is very straightforward, and the basic options are set out on this page of the HMRC website.

Self-employed people usually have to pay Class 2 National Insurance contributions at a rate of £2.30 per week (in practice they are paid monthly or quarterly). However, if expect your self-employed income to be less than £4,825 per year, you will can apply for an exemption. For further details, see here.

As someone with self-employment income, you will be sent a self-assessment tax return in April every year, on which to report your total income (both employed and self-employed) for the tax year that has just finished. You will need to keep records of your business income and expenses so that the tax return can be completed.

How much will the tax be?

In working out the tax, you generally pay tax on your employment income through PAYE on your payslip each week or month, and tax on your business income based on the amount of profit (not turnover) that gets entered on your tax return each year.

Your tax-free Personal Allowance usually gets allocated to your employment, so the tax on your self-employment will be at your own highest tax rate. If your total income is below £41,435, the tax on your self-employed income will be 20%, but any income over £41,435 will be taxed at the higher rate of 40%.

Additionally, you pay Class 4 National Insurance on your self-employed earnings at a rate of 8% on any income between £5,435 and £40,040 in a year, and just 1% on any income over £40,040. There is a National Insurance payment ceiling that caps the liability if the total amount of NI that you are paying on both your employment and your business is over a set limit for the year.

It is useful to know what percentage of self-employed earnings should be set aside for tax, but as seen, this is not possible. The amount could vary from 20% to (possible, but rare) 48%. For someone with average earnings, we recommend setting aside around 25%, and then completing the tax return shortly after 5 April each year so that you get several months’ notice of what the final liability will be.

When will the tax have to be paid?

The total tax and Class 4 National Insurance on your self-employed income (together with any other minor tax adjustments that get sorted out on the annual tax return) is usually payable by 31 January after the end of the tax year. So, if you started your business in October 2008, this falls in the tax year to 5 April 2009, and the tax on the business income up to 5 April 2009 will be payable by 31 January 2010.

If the tax and NI on your self-employed income is over £500 per year, and this total is more than 20% of your total tax paid for the year, then you may have to start making advance payments on account of tax every 6 months.

Simple example for first year of business

The business starts in September 2008, so it should be registered with the tax office by the end of December.
Annual salary = £20,000.
Profit from self-employment in year to 5 April 2009 = £6,000.
Tax on self-employed income at 20% = £1,200.
Class 4 National Insurance on self-employed income at 8% on earnings over £5,435 = £45.20.
Combined amount payable by 31 January 2010 = £1,245.20.
As this is more than £500, and it is more than 20% of the total tax paid for the year, a payment of £622.60 (50% of the January payment) will also be required in January 2010 and July 2010. These payments can be deducted from any tax due in January 2011.

For professional help with your self-assessment tax return, please see our tax returns page.