Many freelancers will ‘test the water’ by doing some freelance work around their permanent job before moving to self-employment. But what are the tax implications of freelancing on the side?
Always check your contract
It’s unlikely, but some employment contracts may prohibit you from freelancing or taking on additional employment on the side. Before considering freelancing you should check that this is not written into your contract as you do not want to jeopardise your job or potentially damage your reputation in the industry.
What expenses can you claim as a sole trader?
A sole trader is someone who works as self-employed without operating through their own company or partnership. As a sole trader, you can offset certain business expenses against your income and you will only be taxed on your self-employed profits. The general rule of thumb is that you can only claim expenses on costs that are wholly and exclusively incurred for business.
Declaring income earnt from freelancing to HMRC
If you get paid more than £1,000 during a tax year and plan to further your freelancing career, you need to register online and complete a self-assessment tax return to declare your income.
You can register here.
You are required to declare your freelance earnings each year by the 31st January deadline following the end of the tax year on 5th April. Unlike the income earnt from your permanent employment, the money you earn from freelancing is untaxed and it will need to be declared to HMRC.
The amount of tax and National Insurance Contributions (NICs) that are due will depend on how much you earn as a freelancer and how much you are paid in your full-time job.
What Income Tax are you required to pay as a freelancer?
Your Income Tax will be calculated on your total earnings – combined income from employment and sole trader profits. You will need to pay Income Tax on any income above the personal allowance of £12,500 for the 2020/21 tax year.
The Income Tax Rates for the 2019/20 tax year are as follows:
- Basic rate (20%) tax is due on income up to £37,500
- Higher rate (40%) is due on income from £37,501-£150,000
- Additional rate (45%) is due on income of over £150,000
When you file your self-assessment tax return, you will disclose the tax already paid on your earnings from your employer. HMRC will then work out the amount of tax due on your profits from freelancing when you submit your self-assessment tax return.
Please be aware that if the profits earnt from freelancing push your total earnings into a higher rate tax band, you will be required to pay the higher rate tax.
How much National Insurance should you pay as a freelancer?
The amount of NI you pay on your income from your permanent employer will not change, but depending on how much you earn freelancing you may be required to pay Class 2 NI or Class 2 and 4 NI.
If your profits earnt from freelancing exceed £6,475 in the tax year you will have to pay Class 2 NI. This is a flat rate of £3.05 per week which is paid via direct debit to HMRC.
Class 4 NI – which is charged at 9% – will also be due on self-employed profits between £9,500 and £50,000. For all profits greater than £50,000 the Class 4 NI drops to 2%. Your Class 4 NI will be worked out when you submit your self-assessment tax return.
Register for VAT
If your annual turnover is more than £85,000 in the previous 12 months then you will be required to register for VAT. Until you reach that threshold it is entirely up to you whether you register or not.
If you register for VAT as a sole trader the business will be registered in your name, unlike limited companies which are registered in the name of the company.
Have you considered operating through your own limited company?
As a sole trader, your business is not a separate legal entity to you. This means you are responsible for any debt or losses incurred by the business. However, if you have a successful freelancing career you can keep all your business’ profits after the tax has been paid.
It may be worth considering setting up your own limited company as it separates the company’s assets and liabilities from your own. Plus, you will still have complete control of your businesses financial and legal decisions.
Churchill Knight & Associates Ltd can support you in your freelancing career with our range of bespoke and all-inclusive accountancy packages. If you are unsure which business set-up you are more suited to, why not speak to one of our friendly professionals for a free and impartial consultation on 01707 871622.
Founded by an IT Contractor in 1998, Churchill Knight has become one of the most respected contractor accountants in the UK. We’ve helped over 20,000 contractors with their accountancy requirements. As well as our accountancy services, we also have an industry-leading PAYE umbrella company and dedicated in-house personal tax department. Whichever service you choose, you can move forward with complete peace of mind. We are proud of the reputation we’ve built over the years, and our FCSA accreditation proves how committed we are to compliance within our sector. Keep reading…