A Quick Guide: Freelance & Self-employed Tax and Accounts:
Entering the world of the Freelance & Self-employed means having to deal with annual accounts and tax returns, whatever the size or structure of your business. It can all seem daunting and overwhelming at first, but following a few simple rules and processes will make keeping your accounts up to date as straightforward as it can be.
Coconut’s Elaine Clark – who is also the Managing Director for CheapAccounting.co.uk – provides IMS StratNews with this exclusive and excellent quick guide, which will take you on a whistle-stop tour through the maze of rules and regulations for Freelance & self-employed workers, giving you a taste of what you need to know to get started!
Starting to trade
As soon as you start to trade you need to register your business with HMRC. However it’s not always clear when your business formally starts, as you may have some pre-launch tasks to do, stock to buy or contracts to secure. Unfortunately HMRC isn’t much help either as they provide no guidance on the definition of starting to trade. The best approach is to register with HMRC sooner rather than later and, in particular, before you make your first sale.
You can do this online at https://www.gov.uk/log-in-register-hmrc-online-services/register
You can of course claim for pre-launch costs incurred through your business even if they were paid out of your own funds. Keep receipts and invoices then record the amounts spent in the accounts once you register it for taxes, showing the total spent as an amount that the business owes to you.
Sole Trader or Limited Company
The taxes that you’ll register for with HMRC will depend on what structure you choose for your business, in a freelance & self-employed capacity.
By far the simplest of structures is that of a sole trader.
A self-employed person working on their own is a sole trader.
There is no formality to setting up as a sole trader as there is no distinction between you and your business; basically you just get started.
A sole trader is an unincorporated business structure meaning that you have unlimited liability (responsibility). This means that you are personally liable or responsible for the debts of the business should it fail. Creditors (people or businesses that you owe money to) could attempt to recover any amounts owed to them from your personal assets including your house.
A limited company is an incorporated business established through a formal process and registered at Companies House. A limited company has its own separate identity in the eyes of the law; a company can trade, own assets, incur liabilities and be sued.
Ownership of a limited company is by way of shares allocated to and purchased by shareholders. The shareholder(s) appoint director(s) to run the business on their behalf. Directors have legal obligations bestowed on them when they are appointed, including keeping accounting records and filing accounts. Of course, the shareholder and director can be one and the same person, as is often the case in an owner managed business.
The distinction to remember is that shareholders own the business while directors are appointed to run it. The clear advantage of setting up a limited company and trading through such a business structure is the protection of limited liability; if the company fails the debts remain with the limited
company and aren’t passed on to its directors – unless there has been some wrongdoing.
Simply put, the shareholders (business owners) liability is limited to their investment in the company i.e. how much they agreed to pay for the shares unless of course they give personal guarantees on the debts. Hence the term limited liability.
The taxes you pay
The business structure that you operate under will determine the taxes that are paid.
In the past the attraction of a limited company has been enhanced due to lower taxes on the profits extracted from the business. That tax advantage has been eliminated for many with the introduction of the dividend tax. So, unless you have large profits, then operating as a sole trader might be the preferred route.
Sole Trader
Depending on profit levels a sole trader will pay:
● Class 2 National Insurance – a fixed weekly amount
● Class 4 National Insurance – a percentage based on profit
● Income tax
Class 2 and 4 National Insurance is explained at https://www.gov.uk/self-employed-national-insurance-rates
Income tax is explained at https://www.gov.uk/income-tax
Limited Company
A limited company pays corporation tax on its profits. The directors of the limited company may need to account for any salary paid on their self-
assessment. If they are also a shareholder and in receipt of dividends, these need to go on to the self-assessment as well.
Employer
If either a sole trader or limited company employs anyone then they will, subject to conditions, have to run a payroll and pay PAYE.
A director of a limited company can pay themselves a salary or wages but a sole trader cannot pay themselves.
Deadlines and Filing
It’s really important to keep on top of your deadlines and filing responsibilities. Generally HMRC and Companies House, for limited companies, will write to you about your deadlines.
Of course the correspondence will only reach you if you have told the authorities about any changes in address or if you have mail forwarding when using a registered office service.
Limited Company
For limited companies the accounts will generally be due at Companies House 9 months after the year end. Special rules do apply in the first year, with the accounts being due 9 months after the date of registration of the company. The corporation tax has to be paid 9 months and 1 day after the end of the year with the accounts and corporation tax return being filed with HMRC 12 months after the end of the year, although in practice this is usually done at the same time as filing at Companies House.
Sole Traders
- If you are self-employed as a sole trader you will need to file a self-assessment by 31st January following the end of the tax year (31st October if you are filing a paper return).
- Tax is also due by 31st January and you may have to make a payment on account towards your tax bill for the current year.
- Payments on account are due on 31st January and 31st July.
What you can claim
Often it is obvious if the cost can be claimed by following what is known as the “wholly and exclusively” rule. Wholly and exclusively incurred for the purposes of the trade, profession or business is the tax term which is used by HMRC:
It means any costs that are incurred while attracting more customers or performing the tasks of the business. So things like stock, website costs, hosting, advertising, stationery, software etc would usually all be allowable costs.
However, there are some exceptions to this straight forward rule which can trip you up.
For example, you cannot claim for clothing unless they are uniforms or protective clothing; HMRC says we need clothes for warmth and decency. Entertaining clients is also not an allowable cost for tax purposes; that’s just the rule!
There are specific rules for claiming travel and subsistence costs; generally you have to be travelling for business and not just going to your usual place of work. If you work at home then you can claim for use of home as office, which requires a calculation by reference to the amount of space you use in your home and the time that you use it for.
If in doubt then the gov.uk web site is a good place to check out the specific rules on what you can claim.
Expenses paid out of your own pocket
If you do pay for costs out of your own pocket then you can claim these back from your business. That said, it is much easier to set up and pay all business costs from a separate business bank account. New apps to the market, such as Coconut , allow you to open up a bank account online,
store receipts against bank transactions, and add in the bookkeeping, making keeping up to date in your accounting much simpler.
Capital Costs
Given their almost throw away nature, small items of equipment such as laptops, printers and tablets would generally not be treated any differently to other costs being recorded as equipment in your accounts.
However if you spend money on large items of plant or equipment you would record the items as a capital cost, then claim depreciation in the accounts, thereby adjusting the profit to claim “capital allowances” on your tax return.
Sounds complicated?
Yes it can be, and this might be an area where you would want to get help from an accountant to make sure you get things right!
Registering for VAT
Any business with a turnover over the VAT registration threshold must register for VAT.
Under the threshold businesses can register voluntarily, although it is worth stressing that careful consideration should be given to registration before you do it. Once registered for VAT the business claims back the VAT on its outlays (input tax). However the business must charge VAT on its sales (output tax).
The net of the two is paid over to HMRC if the output tax exceeds the input tax, which is usually the case in business.
A refund will be due if the business incurs more VAT than it collects.
Realistically, this means that if you sell to non-VAT registered businesses or consumers your price will be higher by the amount of the VAT, which could have a detrimental impact on your business when your prices are compared to the competition. So it’s worth thinking this through before you jump into VAT registration.
The VAT Flat Rate Scheme may be a viable alternative to look at (further VAT Flat Rate Scheme details), although this has become less attractive with the Low-Cost Trader Rules. Under the scheme the business must still charge VAT at 20% on all sales.
Here is a list of the percentages paid for each type of business.
Being VAT registered does place an administrative burden on businesses through the quarterly reporting regime, and businesses with turnovers over £85,000 will fall into Making Tax Digital from April 2019.
Making keeping the books easier
For the freelance & self-employed an optional scheme called Simplified Expenses exists aimed at making the recording of costs easier.
This scheme can be used by sole traders and partnerships but not companies.
The rules allow for a flat rate to be used for certain expenses rather than recording actual costs incurred.
The types of expenses covered by this scheme are:
● Business costs for vehicles
● Working from home
● Living in your business premises
Full details of the rules can be found at https://www.gov.uk/simpler-income-tax-simplified-expenses
Making things simple for very small businesses
In April 2017, HMRC introduced the Trading Allowance. This allowance exempts the self-employed with a total annual gross trading income of £1,000 or less from registering for self assessment.
If self-employed income is over £1,000 then the amount can be offset against income, rather than claiming all costs, which can of course make bookkeeping simpler.
Rules apply and full details are explained at https://www.gov.uk/guidance/tax-free-allowances-on-property-and-trading-income
So do you need an accountant?
This is a question often asked by those starting out in business. Strictly speaking there is no requirement for you to engage an accountant, although, if numbers are not your thing or you are too busy running your business then you may want to use one.
The benefits of having a good accountant on board are that they will ensure you meet your deadlines and they will keep you up to date with tax changes as they happen.
There will also be no need to spend hours searching the internet for answers to tax and accounting questions (unless you want to): Forums, searches, articles and blogs can be great sources of information but they are general and may just not be right for your specific needs.
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A Quick Guide: Freelance & Self employed Tax and Accounts: Entering the world of the Freelance & Self employed means having to deal with annual accounts and tax returns, whatever the size or structure of your business. It can all seem daunting and overwhelming at first, but following a few simple rules…
Award winning Elaine Clark, who is a specialist in advising the self-employed and small businesses, has been appointed to the advisory board at Coconut. The firm is an exciting automated smart business current account, built for the unique needs of freelancers and self-employed people. It offers this group the accounting…
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