Self employed taxes

Every person regardless of their employment status has to pay tax. It doesn’t matter whether you are an employee or self employed you will have to pay income tax on your income. Self employed taxes are similar to employed taxes it’s just they are collected in a different manner.

Self employed taxes - Income tax

Out of all the self employed taxes income tax will be the largest bill. A self employed person pays income tax on the profits the business makes, not on the level of drawings taken from the business.

As an example let’s say the business profits were £50,000 but you only took £20,000 from the business. The amount transferred over to your self assessment tax computation would be £50,000 and not £20,000. This may seem a bit unfair but it is swings and roundabouts since another year you may decide to take all the money out of the business account, which for arguments sake is £100,000 but the business only made a profit that year of £75,000. In this scenario the amount transferred to your self assessment tax computation would be £75,000.

In computing the profits chargeable to income tax the business profits would need adjusting for disallowable expenses, such as depreciation and private use of business assets and for other allowances or deductions, such as capital allowances. The net figure is then transferred to your self assessment tax return, along with all other sources of income, to calculate your income tax liability at the appropriate rates.

Self employed taxes - Self employment national insurance contributions

Just because people are self employed it doesn’t make them exempt from paying National Insurance Contributions. Oh no, if you work for yourself you still have to make self employment national insurance contributions to the tax man to ensure you will qualify for the state pension when you reach retirement age. Self employment national insurance contributions are known as class 4 NICs and these are calculated as a percentage of your business profits less the annual allowance.

Self employment national insurance contributions do not have to be made if your business profits are below a minimum threshold. The threshold is very low and if your business profits were below this the business would be in dire trouble and is likely to collapse in the very near future.

Self employed taxes - Constructors Industry Scheme ("CIS") tax

Self employed people working in the construction industry have a special set of rules they must  follow with regards to tax. If a self employed person is a registered subcontractor who carries outwork for another organisation all income for the work performed will be taxed at source and paid net of basic rate tax, which is currently 20%.

So, let’s say you, as a self employed subcontractor does some work for a construction company and you charge them £1,000 for the work. The construction company will pay you £800 (i.e. 80%) and will pay the remaining £200 (i.e. 20%) over to HM Revenue & Customs on your behalf.  When you complete your self assessment tax return you will deduct the £200 from the amount you owe, as you have already paid this over.

Similarly if you, as a self employed person, use the services of subcontractors you must pay them 80% of the invoiced costs and pay the remaining 20% over to HM Revenue & Customs on their behalf. All contractors are required by law to collect the tax in this manner and failure to do so will lead to fines, penalties and potential legal problems.

It is possible for a self employed person to be both a contractor and a subcontractor, which makes things a little bit more complicated.

Self employed taxes - Payroll costs

Just because you are self employed it doesn’t mean you can’t employ any staff to assist with your business. If you take on employees in your business you will have to set up a PAYE scheme with HM Revenue & Customs and collect the tax and national insurance from your employees, and then pay
them over to the tax man by the due dates.

All employers, regardless of whether they area company, partnership or self employed are liable to pay employer’s National Insurance Contributions. This is an additional business expense that is an allowable deduction for business tax purposes. Payroll costs are not a direct self employed taxes cost.

Self employed taxes - Conclusion

As you can see, everyone has to pay tax and self employed taxes are clearly different to employment taxes. The tax authorities are harsh on people who do not pay their tax liabilities therefore if you are thinking of going self employed you need to know how the self employed taxes systems work, and what you must do to ensure you don’t fall foul of the rules.

The main thing about self employed taxes is that you ar responsible for calculating them and paying them over to the tax man yourself, which is something employees do not have to do. If you are unsure about self employed taxes, how to calculate self employed taxes and when to pay self employed taxes over to the tax man you should seek advice and assistance from a professional tax adviser or an accountant.