Imagine submitting your first sole-trader self-assessment tax return, only to find out you owe HMRC £6000 and have no money to pay for it.
It can happen. That’s why working out how much tax you’ll pay when self-employed is important.
So where do you start? HMRC’s tax calculator isn’t a bad bet but read through this quick article first to make sure the figures you’re using are correct.
Let’s get started.
What will you pay tax on?
To use HMRC’s tax calculator properly, you’ll need to know what income you’ll pay tax on.
HMRC tax the following forms of income:
- Your self-employed business profits.
- Income from a trust.
- Interest on savings.
- Money earned from employment.
- Rental income (in some cases).
- Most pensions.
- Some state benefits.
- Some grants.
What won’t you pay tax on?
There are some forms of income that are exempt from income tax:
- The first £1000 of money you earn from self-employment.
- The first £1000 of money earned from property you rent.
- Winning the lottery (if you’re ever that lucky).
- Premium bonds.
- Income from some savings accounts like ISAs and NSCs.
Your tax code dictates your personal allowance. The most common tax code (and personal allowance) is 1250L. This means you can earn £12,500 before paying any tax.
If you claim marriage allowance or blind person’s allowance, your personal allowance may be bigger.
If you have a taxable income of over £125,000, you do not get a personal allowance.
There are some situations whereby money you spend will be added to your personal allowance so you pay less tax.
These include pension contributions, charity donations, and allowable expenses.
The allowable expenses list is vast, which is why we look in-depth at commonly confused allowable expenses as part of our To Claim Or Not To Claim series.
Things like your car, working from home, clothes, and start-up costs all come with their own rules and regulations, so it’s important you understand them before claiming tax relief for them.
Thousands of people overpay millions of pounds in tax every year because of lacking the knowledge of allowable expenses. Don’t let that be you.
Keep receipts for everything and store them electronically in online accounting software. By keeping track and on top of your accounts during the year, it means you won’t miss anything off when you come to complete your self-assessment tax return.
How Allowable Expenses Work
Let’s say you’re a self-employed hairdresser.
You have a brilliant first year, making £35,000 worth of sales.
Your tax-free allowance is £12,500, so you’d pay tax on the remaining £22,500.
Now, as a hairdresser, you’ve got certain bills and expenses you need to pay to run your business.
Let’s say you visit clients at their homes. You’d claim business miles, along with other car-related allowable expenses. Plus, you may have a uniform you wear to work, meaning you can claim the cost of those clothes. You may sell stock, such as shampoos and conditioners, so you’d be able to claim the cost of that stock. Finally, we’ll say you’ve taken out professional indemnity insurance in case you leave some straighteners on a client’s floor or damage their property another way.
If those expenses came to £10,000 over the year, you’d add this figure onto your tax-free allowance.
This would mean:
£35,000 in sales
£12,500 tax-free allowance
£10,000 in business costs
Instead of paying tax on £22,500, you’d pay tax on £12,500, plus National Insurance contributions to take into account, which we’ll look at shortly.
Now you can see why it’s so important to log your expenses and learn about the allowable expenses list.
Most people forget to claim for these ten things when they’re submitting their tax returns, and it costs them thousands every year.
Download our FREE Pay Less Tax guide now to make sure you don’t do that.
UK Tax Brackets
Now we know which income we should pay tax on, what a personal allowance is, and different types of tax relief, let’s look at the UK tax brackets.
If you live in Scotland, your tax bands are as follows:
- Personal allowance (up to £12,500) – 0% tax
- Starter rate (£12,501 to £14,585) – 19% tax
- Basic rate (£14,586 to £25,158) – 20% tax
- Intermediate rate (£25,159 – £43,430) – 21% tax
- Higher rate (£43,431 – £150,000) – 41% tax
- Top rate (over £150,000) 46% tax
As for the rest of the UK, it’s a bit simpler:
- Personal allowance (up to £12,500) – 0% tax
- Basic rate (£12,501 – £50,000) – 20% tax
- Higher rate (£50,000 – £150,000) – 40% tax
- Additional rate (over £150,000) – 45% tax
As well as tax, you’ll owe national insurance contributions. There are two brackets, called Class 2 and Class 4:
- Class 2 if profits are more than £6475
- Class 4 if profits are more than £9501
Class 2 profits equate to £3.05 a week, while Class 4 is 9% on any profits that fall between £9501 and £50,000 and 2% over £50,000.
HMRC will let you know how much NI to pay at the same time as they tell you your tax liability after you complete your self-assessment tax return.
The last thing to consider when saving for your tax bill is your student loan repayments.
It may be when you’re first starting your business you don’t earn over the threshold to repay your student loan, but you never know, business may be booming.
Different repayment amounts and thresholds apply depending on which plan you’re on. So log into your account to double-check.
You should now be able to enter the correct information into HMRC’s tax calculator, which will give you a good indication as to how much tax and NI you will expect to pay.
If any of the above is confusing, it may be worth getting some help. And yes, bookkeeping and accounting is tax-deductible.
Our affordable bookkeeping service starts from as little as £25+VAT per hour and could mean you free up your time to concentrate on your business.
Book a FREE 30-minute consultation with us today to find out how we can help.