Saving taxes – a guide for the self-employed

For people who are self-employed, being well-versed in taxation basics is always worthwhile, particularly because the right knowledge helps you save a lot of money. What taxes need to be paid, and how they are reduced depends on the form of self-employment as there are different tax deductions for business owners and sole proprietors or freelancers.

In this text, we will address and clarify the most important tax questions: What exactly can traders and freelancers deduct from their taxes? Are there other rules for business owners? We provide an overview of what taxes can be incurred, and how self-employed people can save in our 10 step guide to tax.

Different forms of self-employment at a glance

Freelancer, sole trader or business owner? One of the most important questions that arises when starting a business is what category of self-employment you fall under. It is also important because it is also the focus on which taxes are generated and how you can save money as a self-employed person. The following section explains how different independent work fields are distinguished from one another.

Tax tips for freelancers and sole proprietors?

In the UK, you will be taxed by Her Majesty’s Revenue and Customs (HMRC) as  a freelancer or sole trader if you are self-employed. Since you are self-employed, you are responsible for filing your own tax returns. In order to find out what taxes you need to pay, you need to register with HMRC as being self-employed. As a self-employed person, you will be required to pay Income Tax and Class 2 and Class 4 National Insurance. In order to estimate your yearly tax bill, HMRC have a handy tool on their website for calculating your total. If you are filing your tax returns online, the deadline is 31 January after the end of the tax year. If you are filing your tax returns on paper, the deadline is 31 October after the end of the tax year.

As a self-employed person, you need to file your annual tax return and pay estimated taxes on a quarterly basis. It is important to work out your net profit or net loss for the year before you begin filing your tax returns, so that you can find out whether you are required to pay both self-employment and income tax (in some instances, it is not a requirement to pay income tax on annual earnings of £400 or less). You will then also be able to discern which forms you are required to complete and file.

Freelancer, sole proprietor or business owner?What exactly is a freelancer? A freelancer is a self-employed person who works for different employers for different lengths of time. They rarely have a fixed employment relationship, instead accepting orders and contracts from companies and customers and then perform them on a fee-paid basis. Some work independently and others are represented by a freelance agencyHow about a sole trader? A sole trader owns an unincorporated business by themselves, making and/or selling items for profit whether online or in a physical store/market, or are paid for a service. You fall into the general self-employment category if you run your own business and are entirely responsible for it yourself, including location, equipment, any employees you may have and are selling goods or services for profit.

Taxes you may incur

To understand how to save on taxes as a self-employed person, you must know which taxes you are required to pay. Here is an overview of the most important tax categories that can be applied to self-employed people.

Income Tax

Regardless of whether you are a self-employed person, or an employee, everyone is obliged to pay income tax. This tax relates to the taxable profit made by a self-employed person (annual surplus). This is often the most important tax for the self-employed, as many company expenses can be deducted from income tax. If you can reduce your taxable profit, you reduce your tax liability. When filing for income tax, you will need to submit a Self Assessment form to HMRC.

National Insurance

National Insurance are taxes paid by workers and employers in the UK which fund state benefit programs. Benefits that are funded by National Insurance include the Basic State Pension, Widows benefits, Incapacity Benefits, Unemployment and Support Benefits, Maternity and Guardian’s allowance and Administrative costs. Regular workers contribute to National Insurance through PAYE which comes directly out of their paychecks, whereas the self-employed must contribute a fixed payment and then a second payment based on a percentage of net profit up to a particular threshold. Self-employed people are liable to pay Class 2 or Class 4 National Insurance. The Class 2 rate is applicable to those earning less than £6,025 per year, while Class 4 is applicable to those earning over £8,164 a year. You can file these taxes along with your Income tax in the Self Assessment form.

Value Added Tax (VAT)

As a self-employed person you may be required to pay VAT which you can then charge on goods and services you provide to others through your business. The standard rate for VAT is 20%, although there are some exceptions to this. Not all traders are liable to pay VAT because they run very small businesses – if your VAT taxable turnover is less than £85,000 during a 12 month period, you are not required to register for VAT. Registering for VAT can be done using form VAT1. VAT returns are submitted quarterly to HMRC. More information regarding VAT can be found at the website.

Information Returns

As a self-employed person, it is your responsibility to submit supporting documents for all of your tax filings to the HMRC. They will then compare the documents you have supplied to the information on your tax returns to ensure that any and all payment transactions are properly accounted for.

10 Tips for Saving Tax when you are Self-Employed

Reducing taxable profit and saving on your taxes is important for freelancers and sole proprietors to maintain financial strength. Overall, the self-employed enjoy a relatively wide margin of taxation, and have the possibility to deduct a number of expenses from taxation, which above all contributes to them saving on their taxes.

There are a number of expenses that self-employed people can claim to reduce their tax bill. Typical examples of this would be, for example, travel expenses, advertising costs, catering, work equipment or company cars. In order to claim this expenditures in your tax returns, it is of the utmost importance to be able to provide corresponding documents for all expenses in your Information Returns. This is of course, best practice for all business accounting.

Not all of the tax-related expenses mentioned above can be immediately be considered freelance tax deductions or self employed tax deductions - some goods need a longer period to depreciate. Capital allowances are available to mitigate the cost of depreciation, generally at 18% of the cost of machinery and equipment  which permits a taxpaying freelancer or sole trader to gain back some of the cost of certain property items – essentially an allowance for the use and deterioration of property.

So what exactly do self-employed people need to pay attention to in order to save money as efficiently as possible? Here are 10 tips we have summarised for the self-employed.

Business Premises Expense

If you run your freelance business from your own home, or have purchased or are renting a building from which to conduct business then you have the option of filing for a number of tax deductions under the Business premises expense. In the event of an audit by HMRC, you will need to be able to definitively prove that your living space is also your work space. A workspace is a space used regularly and exclusively, and that is the principal location of your business. Deductions are based on what amount of your home is used for your business in terms of percentage. You need to figure out your home office expenses such as rent, phone bills (you can only use simplified expenses if you work for 25 hours or more a month from home).You cannot claim expenses for buying a building to use as an office. You can claim an allowable expense if operating through cash basis accounting, or claim a capital allowance if you use traditional accounting.

Telephone and internet expenses

Similar to the Home Office tax deduction, you are eligible to claim tax deductibles on your business phone and internet expenses. The only difficulty that can arise in this is similar to proving what portion of your house is used for business purposes – you need to be able to prove exactly which calls and what internet usage was made while carrying out business related activities. You cannot claim deductibles on your entire bill, unless you have a specific work phone. Similarly, you need to be able to work out and prove how much of your time spent online was related to business by percentage.

Clothing Expenses

Clothing costs can be expensed in your tax return as long as you can prove that they are directly necessary for your work. This means that you can expense uniforms, and necessary protective clothing, any necessary footwear, specialty items such as hairnets and aprons if working in a kitchen, and costumes for actors and entertainers. Everyday clothing may not be claimed for, even if it is clothing worn to work.

Staff Expenses

If you are a self-employed person who has staff working for them, there are a number of areas where you can claim business deductions for them, such as: employee and staff salaries, bonuses, pensions, benefits, agency fees, subcontractors and National Insurance payments for your employees. All of these expenses can help decrease your overall tax bill considerably.

Subscription Expenses

Self-employed people may claim back the costs of any publication subscriptions they incur, provided those publications assists them in broadening their work skill or are otherwise provable beneficial to the business.Trade and professional journals, as well as memberships to trade bodies and professional organisations may be claimed back if they are business related. Gym and political party membership may not be expensed.Meal and Travel Expenses.

Meal and Travel Expenses

Travel expenses may be deducted if the trips being taken are benefitting the business. Self-employed people may claim back on bus, air, train and taxi fares, as well as hotel or guesthouse bills. Meal expenses fall under more or less the same category as travel expenses – you may be able to claim back some deductible tax on business related meals that you have paid for throughout the year. Business meals in this instance refer to any meals purchased whilst travelling for business. Receipts of these must be kept to provide that the time and date match those of the trip.

Reselling Goods Expenses

Self-employed people may be able to claim back expenses on goods purchased for resale. Stock, raw materials and direct costs incurred from producing goods may be expensed, while any goods bought for private use, or depreciation may not be expensed.

Car expenses

A classic tax saving tip for a self-employed person concerns their company or business vehicle. In the UK, you may file for car expenses in the following areas: vehicle insurance, vehicle repairs and servicing, petrol, parking, vehicle licence fees, and breakdown cover. You may not claim for any driving costs that are not business-related or and driving fines. It may be possible to calculate your car expenses using a flat rate for mileage, rather than the actual costs of running the vehicle.

Legal and Financial Costs

As a self-employed person, you are eligible to deduct taxes for any expenses incurred in hiring legal assistance or financial experts. Expenses can be deducted for hiring accountants, solicitors, surveyors and architects, provided you can prove that they were engaged in work related to the business. You may also make a claim for professional indemnity insurance premiums. Legal fees for buying property or equipment may not be claimed, and neither can fines for breaking the law.

Advertising and Promotion Expenses

In the UK, you may receive a deduction for costs associated with advertising and promoting your business if you are self-employed. Advertising is a broad category, and you will need to be able to prove that the services you are claiming a deductible for directly assisted with spreading the word about your company. Advertising through different media channels such as newspapers, and directories is covered, as well as mail advertising in bulk and free samples. You may also claim a deductible on costs for producing advertising materials such as business cards, posters, brochures, operating your website including site maintenance and hosting fees. It is not possible to claim for event hospitality costs.

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