Self-employment means controlling your hours, your earnings, and the work you take on. But it also means having some control over your tax bill.
As a sole trader or partner, you will be responsible for your own calculations and paying what you owe to HMRC. There is plenty of help and support available to make this easier, allowing you to focus on what you do best.
In this guide, we look at some of the ways in which you can save tax if you are self-employed.
- Claim for Business Costs
If you are self-employed, you can deduct your essential business costs from your turnover to arrive at your net profit. This means that you only pay tax on your own earnings, and not on the outgoings required to keep the business running.
You can deduct the following from your turnover to reduce your tax bill:
- Stationery and print costs
- Travel expenses
- Stock or materials
- Staff or contractor costs
- Insurance premiums and bank charges
- Marketing, IT and web design
- Training materials and courses
- Any costs involved in running your business premises
If you work from home, you can claim a proportion of your household bills as a business expense. You can either work out the precise costs as they apply to your working area and business hours, or claim a flat rate which is based on working hours only.
In 2017, HMRC introduced a simplified approach for businesses with a low level of expenses. You can claim a Trading Allowance £1,000 per year to cover any costs involved. This is available as an alternative to claiming itemised expenses, not in addition.
It’s worth keeping track of your expenses to determine whether the itemised approach or Trading Allowance would be most efficient for your business.
- Claim Capital Allowances
When you purchase capital items for use in your business you can also claim the costs of these against your business profits. For example:
- Tools or equipment
- Cars (although these are treated differently from other items)
Depending on the item and your business profits, you can either claim the cost in a single year (using the Annual Investment Allowance) or over a number of years (using the Writing Down Allowance).
Depreciation in the value of the item is taken into account, and you may need to pay back some tax if you later sell on the item and make a profit.
Claiming for capital allowances can be complex, so it can be worth seeking tax advice, particularly for large purchases.
- Log Your Business Mileage
If your business involves driving your own vehicle, you can also claim mileage expenses. The amount available is:
- 45p per mile up to 10,000 miles
- 25p per mile thereafter
So if you drive 10,000 miles per year for business purposes, you can set £4,500 against your profits for tax purposes.
For most cars, this will more than cover the cost of fuel. It’s also intended to contribute towards:
Of course, if you are claiming mileage allowance, you cannot claim for these items separately.
- Pay into Your Pension
If you are self-employed, you cannot rely on an employer to set up a pension for you. You will need to do this yourself, as well as decide on your contribution rates.
Your pension payments will be classed as personal contributions, which have the following tax benefits:
- For every £80 you contribute, HMRC will credit a further £20, resulting in a gross contribution of £100.
- Your gross contributions are capped at the higher of your trading profits (plus other earnings, for example, if you also receive a salary) and £3,600 per year.
- If you are a higher or additional rate taxpayer, you can claim further tax relief via Self-Assessment.
- When you take benefits from your pension, the first 25% will be free of tax.
- Your remaining pension will be taxable, but can be drawn flexibly.
If your business profits are fairly steady, you may wish to contribute monthly as this sets up a good habit and means you can benefit from regular investing.
However, if your business year involves peaks and troughs, it could be more appropriate to make an annual contribution. This allows you to review your contributions in line with your business profits.
- Save on Childcare
Childcare Vouchers have been replaced with Tax Free Childcare. The scheme works as follows:
- Tax Free Childcare is only available if both you and your partner earn less than £100,000 in taxable income.
- Your child must be 11 or under, or under 18 if they are disabled.
- You need to set up a childcare account with HMRC.
- For every £80 you contribute to your childcare account, HMRC will top this up by £20.
- This means that you have £100 available to pay your chosen childcare provider.
- This must be used to pay for approved, registered childcare.
- There is a cap on the amount that HMRC will contribute. This is £2,000, or £4,000 for disabled children.
- You cannot receive Tax Free Childcare if you are in receipt of Tax Credits or Universal Credit.
- You, and your partner if applicable, must be either:
- On sick leave or annual leave
- On parental, maternity, paternity or adoption leave
- Earning at least the National Minimum Wage for at least 16 hours per week (this does not apply if you have started a new business in the last 12 months)
Unlike the former Childcare Vouchers scheme, Tax Free Childcare is available to the self-employed. It is also a much more flexible arrangement, as you can vary your contribution amounts as your childcare needs change.
- Review Your Business Structure
As a sole trader or member of a partnership, you will need to pay tax on your profits each year. You also need to make National Insurance Contributions.
However, if you incorporate your business into a limited company, you will have much more flexibility.
Most owner-directors take a small salary from their business which falls within the tax-free personal allowance (£12,500 for 2020/2021). If it is also under the Primary Earnings Threshold (£9,500 for 2020/2021) no National Insurance contributions are payable.
The company pays Corporation Tax, but director’s salaries are an allowable business expense.
After deduction of this tax, the remaining profits can be distributed as dividends. This offers the following benefits:
- The first £2,000 per year of dividend income is free of tax.
- The remainder is taxed at a rate of 7.5% up to the basic rate threshold, compared with 20% (up to 21% in Scotland) on other types of earned income.
- Higher and additional rate taxpayers pay tax of 32.5% and 38.1% respectively, compared with 40% and 45% on other income (or up to 41% and 46% in Scotland).
- Dividends are not subject to National Insurance Contributions. However, you can still accumulate a full State Pension providing your salary is over the Lower Earnings Limit (£6,420 per year).
Business taxation can be a complex area, but there are multiple ways to save on tax. Advice is recommended.