How does Self Employment Tax Work in UK?

Are you self-employed and wondering how you pay your tax and what this is all about?

Well, this article is for you as a business accountant see we help business owners all day long and navigate the wide world of tax and a question we get asked all the time from new owners is how do we pay our tax how do we pay our national insurance and what is it all about how does it work and how do we save for all these types of questions. And in this article, I’m going to answer all of those for you and all the key things you need to know.

Now tax can be complex and there are about twenty-two thousand pages of it behind me that required in the UK to make sure you pay the right amount of tax. But default you tend to pay more than the required amount because you just don’t know this stuff and what I’m gonna do here gives you a broad brush general look at some of the key points so there are some specifics that apply in lots of different situations. But for now, these are the key things you need to know starting with as a sole trader or self-employed person you get taxed on your accounting profits now what that means is that quite often that’s not actually relatable to what you get in your pocket. So for example you might draw two and a half grand a month but somewhere in that year you’ve bought a van, currently, vans in the majority of cases allow for all that value of that van depending on how you bought it to be knocked off your profits before you get taxed reducing your tax bill massively so sometimes you might find you get a tax rebate in a year. Where you’ve still taken to an ARFF grand a month for example so it comes down to accounting profit and that’s something that’s quite key to understand is it’s not driven by the amount you actually draw in your bank although sometimes those two are quite related. So we mentioned taxable accounting profit so if you think about that’s not what you’ve had in from all your customers. That’s what you’ve had in from all your customers less all your expenses and then that bit is the bit that you’re gonna get taxed on just as an overall simple example. 


You have to understand that you actually start paying national insurance at a lower level there’s a small amount of National Insurance used to come out quite often people refer to as stamps. But it was a small amount per week that comes out you know generally around a hundred and fifty-two hundred quid depends on the year that you’re listening to this in and that’s paid in your tax return once a year which we’ll talk about in a minute. But generally after the 12 and a half grand you’re then going to pay twenty percent tax and you pay all the way up to fifty grand if you go into 50 grand and over you’re then paying this forty percent. That you might have heard people talk about this forty percent tax I’d argue if you’re starting to pay those levels you should definitely be looking at whether you need to be a limited company. Because overall you can save a lot of tax at that level so that’s there if you’re lucky enough to earn over 150 grand then you start to hit the problems of forty-five percent tax and restricted personal allowances. About 12 and a half grand starts to disappear it before that and another thing so once you’re in those realms and tax is a nice problem to have. Obviously but it is quite a hefty bill to deal with now the way the tax works is you do a tax return every year. So let’s say you you’ve just gone round and you’re the end of the tax year is the fifth of April each year now without going too technical into it you can have accounting years that run differently to tax years. And you can end up paying your profits for a year that doesn’t run alongside the tax year and that can be odd so it used to be cool years ago to have the 30th of April year ends because it delayed when you paid some tax. And all this kind of stuff but for now if you’re starting out self-employed please just think you know what you are gonna keep it in line with the tax you make everybody’s life a lot easier so we are presuming you’ve done that you’re gonna trade. You know let’s just keep it easy and so the first of April to the 31st of March each year or the sixth of April to the fifth of April each year now when that ends you’re going to do your tax return or your account that’s going to do your tax return. And you can end up paying tax presuming that you’ve done well and your national insurance in one bill and that bill has to be paid by the 31st of January each year. So let’s say it’s 2020 now it’s the 5th April 2020 but actually is ended you’re going to have until the 31st of January 2021 to pay that tax bill now where it can sting is if you’ve had a good year and enough to pay over a thousand pound of tax. You’ll actually have to pay some upfront for next year in that January as well in two halves so let’s say your tax bill was 12 hundred pounds so you pay your 12 hundred pounds on the favor January they’d also want 600-pound upfront for next year and the other 600-pound in July 2021 now that sounds bad. But what it does do is they take that into account the following year so presuming you’re going to earn the same amount of money again and your tax bill was 12 hundred pounds you already would have paid the 12 hundred pound and two chunks upfront but they still want the next year’s upfront so it keeps rolling it. 


Keeps rolling what it really means is in the first year you can be out quite a lot of money and the example never works as simple as that so we find it’s quite feast or famine so some clients have massive tax bills. Because they’ve had a massive tax bill they then have to pay massive chunks upfront and you know trade could have gone down a bit that could have bought a van using that scenario. And all these things and then the following year they might even get a rebate but then they’ve paid any upfront and it sort of it’s not a great system but it’s what we have to deal with here in the UK so the takeaway to that is just to make sure that you could have these big chunks each year that you have to pay in January and July. We think when I became self-employed and also when I first became an accountant many many years ago it was one of the things that were hardest to get our head. So it is difficult to explain to somebody without writing it all down but just bear in mind those two chunks that you can have and as a result, what we say to people is to make sure that you save appropriately for that tax. 


Now a golden rule that was taught to me when I first went self-employed many years ago was to save 25 percent of what you earn and that should see you through and then you can have a holiday in the end. Because it’s always going to be too much well actually as a general broad-brush rule that’s not that far off being true and we say to clients all the time does that say 25% and it should see you through roughly by the time you get around of paying it you should have enough to pay the tax and a lot of time. It’s too much because it doesn’t take into account things like allowances. 

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