If you are an employee, your taxes are usually deducted automatically from your pay packet as you earn. But if you work on a freelance basis, it’s a different story.
“Tax isn’t taken out of your earnings automatically, so you need to put money aside to pay the government when the time comes,” Donna Torres, Director of SME and commercial operations at Xero, says.
“This often requires attention and discipline so you don’t get caught out when the bill is due."
Budget like a pro
When it comes to taxes, as tempting as it is to put them off, it’s best not to wait until the deadline.
The first step is to estimate how much you’ll need to pay as this amount will vary depending on what tax rate applies to you and whether you’re registered as a sole trader or a limited company. In England, Wales and Northern Ireland, tax rates for freelancers range from 20% to 45%. In Scotland, the rates range from 19% to 46%.
The government’s tax Self Assessment pages should be your first port of call. There you can register for and file your Self Assessment tax return, as well as find learning resources to help you file correctly, such as fact sheets, videos and webinars. They also have an online ready reckoner tool, but as of publication, it’s under maintenance. When back online, it’s a very useful tool in your freelance arsenal.
Once you’ve estimated how much you will owe, budgeting becomes a lot easier. "Create an organised system, ideally as soon as you start freelancing,” Donna says. “It can be hard to keep on top of things such as expenses, so having separate business and personal bank accounts will make claiming much simpler."
Using accounting software such as Xero or FreeAgent, both of which are available in Starling’s Marketplace, can also help. These tools are designed to help pull exact tax reports so that freelancers can put aside the appropriate percentage of their earnings each month. This way, they know they should have enough to pay their tax bill.
Emily Coltman, FreeAgent’s chief accountant, also advises freelancers to consider opening a bank account specifically for putting money aside for your taxes. In fact, Starling offers both business and personal accounts, which can be used to help keep your tax money separate. Starlings customers can also use the Goals feature of the app to keep the tax money separate from everyday spending.
"You should also always have a backup plan to pay your taxes in case of unforeseen circumstances putting a brake on your cash flow, for example, if a big customer goes out of business or disputes your bill," Emily adds.
Whatever tools you use, it’s important to keep a record of: the number of hours spent working or jobs completed for each client, business expenses and receipts, any payments made including bank transfers and all payments received from clients. Both Xero and FreeAgent offer these functions.
What you can expense
Freelancers can offset many of their expenses against tax. This includes things such as travel expenses, office rent (including a room in your home), power and utility bills, capital expenditure (items such as computers, printers, and phones), internet and phone bills and vehicle maintenance (if your car is used for business purposes).
Generally speaking, you need a justifiable business purpose for any expense claimed as a deduction. This means you need a clear reason why a cost was necessary in the running of your business, for example travel, training or office supplies. HMRC’s website has guidelines on expenses.
What first-time freelancers need to know about taxes
“As soon as you become self-employed, tell HMRC, even if you’re still working for another employer,” Donna says.
The latest you can register with HMRC is by October 5 after the end of the tax year in which you became self-employed. The tax year runs from April 6 one year to April 5 the next, and if you register too late you could be liable to pay certain penalties. So if you started your business in June 2019, you’d have to register with HMRC by October 5, 2020. You can do so on the HMRC website.
You might want to consider hiring an accountant the first time you file a self-assessment. Freelancers aren’t under an obligation to do so, but an accountant may understand any regulation changes better than you will. With Making Tax Digital, the government’s initiative to take taxes online, now coming into force, there are more changes to consider than you might think. If you decide to do your self-assessment solo, here are our tips for avoiding common pitfalls.
New freelancers also need to familiarise themselves with "payments on account", something they may not have heard of before becoming self-employed.
"Payments on account are advance payments towards your self-assessment tax bill," Donna says. "You have to make two of these every year, and each one is half your previous year’s tax bill."
These payments are due by midnight on January 31st and July 31st. The first will settle the previous year’s tax bill, and then you’ll need to have made an advance payment for the current financial year that gets offset against your tax return the following January.
Staying on top of tax is one of the most daunting aspects for many freelancers. However, with the availability of smart digital tools and easy-to-use guidelines on HMRC’s own website, it’s not as big of a headache as you might think.