Keeping track of taxes in the UK isn’t exactly a piece of cake. There are so many types of taxes that it’s difficult to know which ones apply to you and/or your business. If you don’t file your taxes correctly with the HMRC, it could result in penalties, which could cost you dearly. This article gives you an introduction to the main types of taxes in England, Scotland, Wales, and Northern Ireland...
One of the most unpleasant, daunting tasks in a freelancer’s life is preparing and submitting their annual tax return. If you are a freelancer and want to attempt managing your own tax return without the help of a professional, you should have a decent idea throughout the year of what your taxes will be when it comes to submitting season. Keeping on top of your records can save a lot of stress and work.
However, if you have recently become self-employed, you may feel uncertain about submitting your taxes. Questions can always arise when filling out your forms. In this article, we will clarify the most important points and provide you with a step-by-step guide to what is important when submitting a self-employed tax return. The first thing to cover is what taxes you may be liable for as a freelancer.
- What kind of taxes do freelancers need to pay?
- How to submit a tax return: a guide for the self-employed
- When do I need a tax consultant?
What kind of taxes do freelancers need to pay?
Freelancing is a popular choice for many workers in the UK, but for tax purposes, the term does not exist. Freelancers file taxes under the term “sole trader”. There are other self-employed categories too, like being both an employee and owner of a company. You could also be classified as a trader, member of a business partnership or if you found your own limited company. If you are unsure about your working status, please visit this page for more information. Depending on which category you file under, you may be liable to different taxes. For the purpose of this article, we will follow the tax rules for a sole trader. All sole traders are required to pay income tax, National Insurance contributions and possibly also VAT, if earnings exceed £85,000. Taxes are paid by filling out a Self Assessment tax return each year.
Freelancing is a generic term for commercial activities undertaken by sole traders or independent contractors. For tax purposes, there is an important distinction between the two categories when it comes to determining how to tax their income. Please consult this HMRC guide for more information.
Income tax refers to the calculated taxable income from business activities, or in the case of a side job, total taxable income. All self-employed people are obliged to declare income tax, regardless of whether their income comes from a commercial enterprise, rental income, interest income, income from participations, or freelance contracted work. However, this does not mean that you automatically are obliged to pay state income tax: if your income is below the statutory basic tax-free amount, you are not required to pay income tax. At the moment, the personal allowance is £11,850(there are separate thresholds if you are blind, married or your income exceeds £100,000),Self-employed people are always obliged to submit their taxes returns, however, if their income falls below this bracket, they are not subject to income tax.
In 2017, the taxable Personal Allowance was £11,850 for a single individual (under 65), with exceptions for married couples and blind people.
How to submit a tax return: a guide for the self-employed
If you are self-employed and want to submit your own tax returns without the help of a tax professional, there are a few things to keep in mind. Simple tricks and tips can save a lot of work and stress at the end of the year. In the following step-by-step instructions, we explain how the self-employed can pay their taxes correctly without too much effort.
Documenting revenues and expenditures: an overview
The most important thing when filing a tax return is to have a clear, comprehensive overview of your financial year. Whilst there is no actual law in place requiring business owners to keep bookkeeping records, it is in their interest to adhere to the “Generally Accepted Accounting Practice” (i.e., the UK GAAP, an accounting standards created by the UUK Taxes Act) to run their business smoothly, submit their taxes effectively, and explain themselves should they become the subject of an audit by Her Majesty’s Revenue and Customs (HMRC). The same goes for the self-employed. The clearer your records are throughout the year, the easier if will be to submit your tax return at the end of the tax period.
As a rule, two Excel tables are sufficient to clearly document income and expenditure: one for revenue and one for expenditure. These tables should include the date, service provider/salesperson, service or product description, gross amount, and document reference number (for receipts, invoices you have kept as proof of purchase/sale) in separate columns. If you are also liable for VAT, you can create columns for net amounts, VAT rates, and calculated VAT rates. This will help you keep track of things and save work in the long run.
Organisation: collecting and sorting documents
Having revenue and expenses is one thing, being able to keep track of them is another. Business activities always need to be documented, and it is better to have too many than too few. Supporting documents should include receipts for cash payments, transfer receipts, and delivery notes, as well as pay slips, fuel, and entertainment receipts.
Another important benefit of document organisation is the legal obligation to keep receipts. HMRC requires all self-employed people to keep business records for five years in the event of a discrepancy in your tax return that might warrant investigation. You are also required to hold onto your old tax returns for at least 5 years from the 31st January deadline or date of submission.
Whilst there is no law stipulating what kind of bookkeeping system you use, it can often be easier and more accurate to use a digital filing system, as well as retaining your paper slips. Recordkeeping requires a good organisation system right from the start, and should be user friendly so that you can add new documents to your database as you get them. To do this, programs create different folders where collected documents are systematically filed.
If your business is operating with a cash accounting method, then two core folders are usually sufficient:
- Account statement folder, filed chronologically; the corresponding documents are filed behind each account statement (unless you have a monthly cost and can file a monthly copy of a lease agreement, etc.)
- Folder for cash documents, in sequence with a document number
For very small companies, a simpler method of document organisation may work more effectively: a folder that contains documents which are sorted by date and type (telephone bill, postage receipts, office expenses, etc.) is likely to be sufficient. Additionally, account statements need to be stored chronologically, with none absent.
However, if profit is instead determined through the accrual accounting method (profit and loss account and balance sheet), then a different method of document organisation is recommended:
- A/R invoice folder, sequential with document number
- Incoming invoice folder, sequential with document number
- Account statement folder, sorted chronologically
- Cash book folder including supporting cash documents, sorted and documented chronologically
Since receipts need to be kept for several years, and machine receipts fade quickly, they should be kept together with backup copies if possible.
Calculating profit: cash method or balance sheet?
Through the topic of determining profits, we are slowly coming closer to the actual tax return. This is because the amount of income tax you pay depends, amongst other things, on how much taxable profit you have made – so one of the first questions that arises in a tax return is how to correctly calculate your profit. There are two options for calculating profit: Profit is either determined through the accrual accounting method using a profit and loss account and a balance sheet, or by the cash method – where expenses aren’t recognised until the money is actually paid out.
As a self-employed person, you can enjoy a few advantages when it comes to submitting taxes. Whilst larger corporations and individuals may have other specific accounting obligations when it comes to proving profits, a simple profit report is sufficient for the self-employed. A profit report simply refers to the amount of revenue from sales that exceeds running costs of the business, and can be ascertained by simply subtracting your business outgoings from your business earnings. Depending on whether your profits are higher than your expenditures, you fill out different sections of your self-employed tax return (page 1 of the form 1040).
As well as popular accounting programs which can help creating a balance sheet, there is also software available to help you work out your net profit.
There are definitely advantages and disadvantages to working out net profit from cash-based accounting, and using the accrual method with a balance sheet and profit and loss margins. Depending on how complex your business’ structure is, and how consistent your profits are, both options can be beneficial.
Savings: what can I deduct?
Car expenses, office supplies, purchasing goods, travel expenses, rent (for business premises), employee wages – there are many categories of expense that the self-employed can deduct from their tax payment, since many operating expenses can be fully or partially deducted from income. This reduces taxable income and the amount of income tax to be paid. The self-employed have a pretty wide scope here, but also run the risk of having their expense claims denied.
When it comes to determining profits, the self-employed should always take into account which items can be deducted from their income. Typical costs that can be fully or partially deducted include:
- Office supplies, books
- Rent (for business premises)
- Training and (relevant) educational costs
- Wages paid
- Cars and other fixed assets liable to depreciate
- Individual retirement plans (IRAs)
- Entertainment costs
- Travel expenses
There are some other items that cannot be deducted directly from tax returns, but can be written off over several years: typical depreciable items are known as durable assets, i.e. purchases of greater value that have longer lives (machinery, computers, office furniture, company cars).
Submitting: filling out your forms and submitting self-employed tax returns
Self-employed people have the option to submit their taxes electronically (through HMRC’s free Self Assessment online service), through the post, or through a registered tax professional.
Which forms exactly do you need to fill out? All self-employed people must submit yearly self assessment tax returns to ensure that their National Insurance and income taxes are being paid. To do this, you are required to submit an SA100 form.
There are several other forms you may need to fill out, depending on what kind of income your business makes. For a full list of supplementary pages, please visit this list.
Once you have completed these forms, the tax return needs to be filed within the deadline. The 2018 tax year came to an end on April 5th. The deadline for registering for Self Assessment is 5th October,2018. Paper tax returns must be submitted by 31st October 2018, and online tax returns are due on the 31st January 2019.. Please keep an eye on the HMRC website, as these dates may be subject to change. Submitting late will incur a £100 fine.
Review: lodging an appeal
One you have submitted your tax return, there is nothing to do but wait. Forms submitted electronically are generally processed within 21 days, and mailed returns can take from 6-8 weeks to be processed.
Once you receive your tax bill from HMRC, it is good business practice to have each tax assessment checked by a professional. After all, even tax officials can make mistakes. Once you receive a determining from HMRC, you have 30 days to launch an appeal. This must be done in written form, and your appeal request should be posted to your local HMRC office, and should include your name, tax reference number, issues with the decision and what you believe the correct tax calculation to be. You must also sign the document.
When do I need a tax consultant?
Should the self-employed file taxes themselves, or is it better to have a specialist do it for them? This depends on the situation, but if hiring a tax consultant is an affordable expense, it is worth considering. Hiring a professional has considerable advantages: they save themselves a substantial amount of work, and do not have to worry about having incorrectly submitted documents.
The decision mainly depends on two aspects: how profits are determined, and what size of business you run. Although a net profit calculation is simple, if you choose to go for a balance sheet, this can be much more complicated, and it would be advisable to consult a tax professional. When you reach the point where you have multiple employees, many business owners find the tax submission process to be too complex to undertake alone.
Conclusion: under no circumstance are you legally obliged to hire a tax consultant. However, if your business activities are extensive and you have a complex method of profit determination, a tax consultant is recommended. Regardless of whether you choose to avail of professional help, all self-employed people should have good knowledge of how their taxation works – if they constantly rely on external individuals to handle their tax issues, business decisions may be made from a point of ignorance, which could damage the company from a tax perspective. Having a basic understanding of taxation will help you run your business more consciously and will help you avoid financial disadvantages – with or without a tax consultant.