Tax on self-employment income while remaining employed
“I have a full-time job, but I have started doing some freelance work in my spare time. What do I need to do about my taxes, how much tax will I have to pay, and when?”
All figures have been updated for businesses starting in the tax year ending 5 April 2014, who will be required to submit their first tax return by 31 January 2015.
Have you started a business, or is it just casual income?
There are some small differences in the tax system between running a business (also known as “trading”, being “self-employed”, or being a “sole trader”), or just having some extra casual income. As everyone’s situation is slightly different, there are no hard and fast rules to help you decide; you will have to make your own judgment. These are the sort of legal grey areas that the courts have been arguing over for decades, without coming to a definitive conclusion that can apply to everybody.
Broadly, you are likely to be running a business if you have a regular, organised activity with a profit motive, which continues for at least a few months. If the work is one-off, or very occasional (say, a few times per year), or not very organised, or of very low value (say, under £2,000 per year), then it might qualify as casual income.
If your extra income comes from eBay or other similar online selling, you might find this page helpful: Paying tax on eBay income.
If you are unsure, and do not want to risk the consequences of making the wrong choice, you cannot go far wrong by treating it as a full business.
You do not need to form a separate limited company in order to do any extra work outside your main job. Running a business through a separate limited company is a much more complicated set-up, and beyond the scope of this page.
Do you have to declare your extra income?
Whichever type of income it is, if there is tax to pay as a result of it, there is a legal requirement to notify HMRC (”the tax man”) about it. This is highly likely if your combined income from employment and your other income is over the tax-free Personal Allowance of £9,440 and there are no other complicating factors. You cannot wait for HMRC to take the initiative and get in touch with you first.
It makes no difference if you are already paying tax on your employment income through PAYE. Tax is always calculated on total income, and there are no allowances or registration exemptions specific to each type of income. For example, if your employment earnings are over £9,440, and your business/casual income is only £500, in most cases there will be tax to pay on that income and so you must declare it.
How to declare your casual income (if it is not a business)
This is a relatively simple matter of registering for Self Assessment for the first tax year in which you had the income. You can do this by completing and submitting the paper form SA1, or by using this page on the HMRC website. The time limit for registering is 6 months after the end of the tax year in which you first had the income.
If you are already registered for Self Assessment and completing tax returns for some other reason, there is no need to register again.
Shortly after the next 5 April, you will be sent a notice to complete a tax return for the tax year just ended. To declare the casual income, include it in the “Other Income” section. If you are submitting the tax return on paper, assuming the box numbers stay the same, it goes in boxes 16 and 17 on page TR3. You will also need to complete the Employment section with details of the income from your job, as this is important in getting the tax right for the year.
The casual income is then calculated and taxed in the same way as business income, as described below. It is not subject to national insurance.
How to register a new business with HMRC
It is currently HMRC policy that all new businesses should register with them, regardless of size and even if there will be no tax or national insurance to pay.
You only register as a self-employed person once, regardless of how many different businesses you have.
Registering is straightforward, and can be done online on this page of the HMRC website.
Registering as self-employed in this way does not mean that the tax office will tell your employer about your sideline business, as your own tax affairs are confidential. Your PAYE tax code will not need to change, unless, when you are completing your tax return, you ask for the tax on your self-employed work to be collected through your wages in the following tax year. This is completely optional, so your tax code does not need to change if you do not want it to. See: Will my employer find out about my business?
Self-employed people usually have to pay Class 2 National Insurance contributions at a rate of £2.70 per week (in practice they are paid monthly or 6-monthly). However, if expect your self-employed income to be less than £5,725 per year, you will can apply for an exemption. See more about Class 2 National Insurance.
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. You can choose to prepare your business accounts to any date each year, rather than having to use the anniversary of when the business started. 31 March or 5 April are the simplest options for tax purposes, so most people choose one of those.
How to work out your extra taxable income
There is nowhere near enough space to cover every accounting adjustment and allowable expense here. Generally, expenses are allowed if they are incurred for business purposes. For expenses with joint business and private use, such as telephone and motoring expenses, you can usually claim the business proportion, which might be 10% or 25% if you also have a full-time job. You can also claim a small proportion of your household running expenses, to cover using your home for business purposes. The exact proportion will depend on whether you have a dedicated office, or just a desk in the corner of a multi-purpose room that you use once a week for admin.
The purchase of equipment, which is generally more expensive items that are going to stay in your business for more than a year (rather than for sale as stock), is not a business expense. Instead, tax relief is given in the form of capital allowances. For most items, this simply means claiming the same amount of tax relief, but under the heading of Annual Investment Allowances. With cars, the position is more complicated.
When working out your profits on which tax is payable, 2 common mistakes are:
- Thinking that if all income is reinvested back into stock, there are no profits and so no tax to pay. In fact, buying stock is a payment, but not an expense. It only becomes an expense when you no longer have it, usually because you have sold it. You pay tax based on profits, not payments.
- Thinking that if all income is left in a business bank account or a PayPal account, there are no wages/drawings, and so no tax to pay. In fact, with self-employment there is no distinction between business money and private money, so there is no question of paying yourself a “wage”. You pay tax on profits as they are earned, regardless of how you transfer your own money around.
For the tax year ended 5 April 2014, most small businesses have been allowed for the first time to submit tax figures on a cash basis. This means that you work out your income using payments and receipts, without having to make adjustments for stock in hand, or other accounting adjustments which allocate income more realistically between different years.
You have to opt in to using this method on the tax return, and it comes with some drawbacks, such as not being able to offset any “losses” against other income, and a cap on the amount of interest you can claim.
Using this method will result in paying lower tax when your stock is increasing, and paying more tax when your stock is going down. Over the lifetime of the business, it shouldn’t make any overall difference.
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 £41,450, the tax on your self-employed income will be 20%, but any income over £41,450 will be taxed at the higher rate of 40% (income above £150,000 may be taxed at 45%).
Additionally, you pay Class 4 National Insurance on your self-employed earnings at a rate of 9% on any income between £7,755 and £41,450 in a year, and at 2% on any income over £41,450. If your combined income goes over £40,000 in the tax year, the amount of Class 4 NI payable starts to be restricted (more details).
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 59% (possible, but rare). 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 2013, this falls in the tax year to 5 April 2014, and the tax on the business income up to 5 April 2014 will be payable by 31 January 2015.
If the tax and NI payable from your tax return is over £1,000 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.
Alternatively, provided your tax return is submitted online by 30 December, and your combined liability for 31 January is less than £3,000, you can pay the tax by having it deducted from your salary via PAYE throughout the following tax year. This will result in your tax code changing, which will signal to your employer that you probably have another source of income. If you do not want the tax to be collected this way, tick box 2 on page 5 of the tax return before filing it.
Once the tax return is submitted, you will receive statements in the post confirming the amount of tax payable and explaining how it can be paid.
Simple example for first year of business
Annual salary = £20,000. Assume a standard tax code of 944L, with no complications.
The business starts in September 2013. Profit from self-employment in year to 5 April 2014 = £10,000.
Tax on self-employed income at 20% = £2,000.
Class 4 National Insurance on self-employed income at 9% on earnings over £7,755 = £202.05.
Combined amount payable by 31 January 2015 = £2,202.05.
In addition, as this is more than £1,000, and it is more than 20% of the total tax paid for the year, extra payments (on account) of £1,101.02 (50% of the January payment) will also be required in January 2015 and July 2015. These payments can then be deducted from any tax due in January 2016.
Alternatively, the £2,202.05 liability can be paid through PAYE evenly throughout the 2015/16 tax year.