If you are self-employed, whether a sole trader or partner, your business is not a separate legal entity. This means that you can expect to be taxed on your income from self-employment in a similar way to an employee. Here we look at the UK personal taxation system and the amounts of income tax and National Insurance you might expect to pay in the current tax year (2013/14).
A partnership is an arrangement between two or more people who carry out a business activity together. All partnerships should have a partnership agreement, which sets out how the partnership’s profits will be shared between the partners. In addition to the requirement for each partner to submit their own tax return, the partnership must submit a Partnership Tax Return, which shows each partner’s share of the partnership profits. These shares of profit are then taxed as the income of the relevant individual.
All income from employment or self-employment, and a number of other sources, is subject to income tax. One of the most complicated aspects of income tax is the calculation of an individual’s personal allowance. This is the amount of income which is not subject to income tax, and the standard personal allowance is £9,440 per annum. However:
- Those born between 6/4/1938 and 5/4/1948 receive an allowance of £10,500
- Those born before 6/4/1938 receive an allowance of £10,660. (People in these two categories see their allowance reduced by £1 for every £2 by which income exceeds £26,100).
- Those earning over £100,000 per annum lose £1 of personal allowance for every £2 by which income exceeds £100,000, until the allowance is used up. (So an individual earning £118,880 or above has no personal allowance, while one earning £110,000 loses £5,000 of their allowance)
On top of the personal allowance, deductions can be made for pension contributions and for costs related to employment. Self-employed persons should note that the latter can only be used where the costs relate entirely to employment, so for example costs of maintaining your office at home do not count.
The amount of the relevant personal allowance and any other allowable deductions is then deducted from total income to calculate ‘taxable income’. Taxable income from employment and self-employment is then taxed according to the following bands:
- 20% tax is paid on the first £32,010 (the basic rate)
- 40% tax is paid on the next £117,990 (the higher rate)
- 45% tax is paid on the remainder (the additional rate)
So for example:
- A 50 year old earning £52,000 has taxable income of £40,560 (£52,000 less the personal allowance of £9,440 and £2,000 worth of pension contributions and allowable expenses). The first £32,010 is taxed at 20% (£6,402), and the remaining £8,550 at 40% (£3,420), giving a total tax liability of £9,822.
- A 60 year old earning £160,000 has no personal allowance, so the full amount is considered to be taxable income. The first £32,010 is taxed at 20% (£6,402), the next £117,990 at 40% (£47,196) and the remaining £10,000 at 45% (£4,500), giving a total tax liability of £58,098.
Self-employed individuals, like their employed counterparts, are also subject to an additional tax on their income in the form of National Insurance (NI). The self-employed pay Class 2 NI contributions at a flat rate of £2.70 per week if net profits exceed £5,725 per annum. They may also pay Class 4 NI of 9% of profits between £7,775 and £41,450, plus 2% of profits above £41,450.
So for example:
- A self-employed person with net profit of £50,000 pays Class 2 at £2.70 per week, equivalent to £140.40. They also pay Class 4 at 9% of profit between £7,775 and £41,450 (£3,030.75) and 2% of profit between £41,450 and £50,000 (£171). The total NI liability is £3,513.15.
Collection of tax from the self-employed
The usual method of collecting income tax from the self-employed is for each individual to make a declaration of their net profit under Her Majesty’s Revenue & Customs (HMRC)’s self-assessment procedure. HMRC then calculate the tax due and collect payment via direct debit or another method. Income tax and NI are payable at six-monthly intervals.
However be prepared as some sole traders, partnerships and limited companies find dealing with.
Value Added Tax (VAT) – a self-employed person must register for VAT if turnover exceeds £79,000 per annum. They then charge their customers the appropriate rate of VAT for the goods and services they provide – most have a VAT rate of 20%, although for some goods and services it is 5% and for others 0%. The self-employed must pay the appropriate rate of VAT on purchases made, regardless of their turnover.
Capital Gains Tax – paid on the disposal of many assets where there has been a gain in value
Inheritance Tax – payable on estates valued at £325,000 or above (£650,000 for a couple)
Corporation tax – payable on taxable profits of a limited company and is currently set a 20% of profits up to £300,000
Want more information? Have a look at our ultimate guide to freelancing and expenses.