How are you taxed and what are the special rules for certain types of workers? 

When you are self-employed you have to account for and pay, your own tax and National Insurance Contributions (NICs) to HM Revenue & Customs (HMRC).

• The amount of tax and NICs you pay is based on your accounting profits earned in the tax year.
• Your accounting profit is your self-employment income less your expenses.
• This accounting profit may then be adjusted for various tax allowances or add-backs. 
• To work out how much tax is due, you need to add up your profit plus all your other income from different sources e.g. employment, bank interest, dividends, and then deduct your personal allowance and any other tax allowances. The result is then taxed at a basic or higher rate and NICs will be calculated based on your profit.
• Expect your tax bill to be something like 10-29% of your profit. The size of your tax bill will depend on whether you have other income to use up your tax-free allowances and what expenses you can claim to reduce your profit.

There are different ways of accounting and claiming your expenses.

• This guide shows a business operating on a cash received/cash paid basis (the Cash basis), claiming actual expenses.
• Other guides take a closer look at what you can claim and look at alternative claims and reliefs on offer.
  • See What expenses can I claim?

Worked example

• James decides to run his own business as a self-employed musician.
• He prepares his accounts for each tax year.
• The tax year starts on 6 April and ends on the following 5 April.

In the tax year 6 April 2020 to 5 April 2021, he earns £25,000 per year from session work, gigging and busking.

He claims tax relief on his business costs of £5,000 which are incurred on:

• Working from home: light and heating costs (he has studio where he writes and practices).
• Travel to and from gigs. He is based at home and the gigs are all irregular.
• Food and drink costs when he is travelling for work.
• Accommodation costs where work requires him to stay overnight as he is unable to get home.
• Replacing and repairing his instruments.
• Telephone and office costs.
• Stage costume.

He has also bought a new laptop and a van for his work this year. These cost him £3,500.

His total costs are £8,500 (£5,000 + 3,500), making his profit for the year £16,500.

His accounts for the year ending 5 April 2021 are as follows:

Account name	£
Sales	25,000
Expenses:
Direct costs (stage costumes)	800
Use of home	550
Office costs (telephone)	400
Motor and travel	2,500
Subsistence	500
Accommodation	100
Repairs & renewals	150
Total expenses	(5,000)
Net profit (Sales - expenses)	20,000
Less capital equipment costs	(3,500)
Profit for tax	16,500

 

Other income for 2020-21

• He has earned £25 in interest and received £250 in dividends from some shares left to him by his grandmother.
• He also earned £1,500 working as a barman. His employer deducted £300 in tax from his employment income.

Notification of liability

• James should have notified HMRC when he commenced self-employment. The deadline for notifying is 5 October following the end of the tax year in which self-employment commences. 
• HMRC will then send him a notice to file his tax return for 2020-21.

Tax and tax return

• James must submit his 2020-21 return online by 31 January 2022, or to the date specified on HMRC's notice (if later).
• He enters his self-employed details in the self-employed section of the return,  his employment details in the employment section and the interest and dividends income in the savings and investment pages.
• To complete his return he needs to know his tax reference (UTR) and his National Insurance number (NINO) and his employer reference (this is from his P60 or P45 issued by his employer).

Tax calculation

His tax is calculated according to the return entries as follows:

2020-21 tax year	£	£	Tax due
Employment income		1,500
Self-employed income	20,000
Less: capital expenses	(3,500)
Taxable profit		16,500
Interest	25
Less: savings allowance	(25)
Taxable savings income		0
Dividend	250
Less: dividend allowance	(250)
Taxable dividend income		0
Total income		18,000
Less: Personal allowance		(12,500)
Taxable income		5,500
Tax @ 20%		1,100
Less: tax deducted at source		(300)
Tax due			800
National insurance
Profit	16,500
Lower limit	9,500
Profits for NI	7,000
Class 4 NI @ 9%			630
Class 2 NICs (flat-rate £3.05 p.w.)			159
NICs due			789
Total tax & NI payable			1,589

 

He will then pay tax as follows:

Date	Detail	Tax
31/1/2022	Final payment for 2020-21	1,589
	1st Payment on account for 2021-22*	715
31/7/2022	2nd Payment on account for 2021-22*	715
31/1/2023	Tax liability for 2021-22	?
	Less: Payments on account already made**	(1,430)
	Final payment for 2021-22	?
	1st Payment on account of 2022-23

 Notes

*

• Your first and second 'payment on account' is calculated as half of your tax and NI liability (excluding class 2 NI) for the previous year.
• You only make a payment on account if your tax liability is £1,000 or higher.

**

• Your payments on account are payments of tax in advance of the following year and so these are deducted from your following year's tax bill.

We don't know what James' tax bill is for 2021-22 so this is added when he files his next tax return. 

Due to COVID-19 it is possible that his income for 2021-22 will be lower than 2020-21. If so, he can ask HMRC to reduce his payments on account for 2021-22.

Next guide in this series

Agency/umbrella tax-avoidance risk
How to check whether your agency is putting you into an illegal tax avoidance scheme.