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Freelancers are, once again, on the rise. According to data shared by the Federation of Small Businesses (FSB), there are well over 3 million sole proprietorships in business, constituting over half of all businesses in the private sector. While a small drop in freelancers occurred after the coronavirus pandemic, more people are starting once again to leave salaried employment in search of autonomy and entrepreneurship. But one of the leading roadblocks to freelancing is tax; what should you know about tax when it comes to your small business?
How to Navigate Tax as a Freelancer?
What Tax Do You Pay?
For freelancers in the UK, though, there is one primary form of tax with which you will need to engage: Income Tax. This is often confusing for those new to sole proprietorships but ultimately makes the running of small and one-person enterprises much easier in the long term.
For sole traders, any profits generated by their enterprise are treated by the government as personal income. As such, they are beholden to the same frameworks as salaried income, paid to employees by a larger employer. There are other forms of taxation, too, that we will touch on – but if your business is complex enough that more than one form of tax needs to be considered, counsel from experts would be advised in order to avoid potential legal issues.
Income Tax Explained
Income Tax is a marginal tax rate, that applies to any money treated as income by the government. In salaried employees, Income Tax is applied monthly on each payslip in accordance with their projected annual salary for that tax year. For freelancers, their Income Tax obligation comes via the submission of their Self-Assessment tax return, at which point they are liable to pay the full amount of tax owed for that year.
When a tax is described as ‘marginal’, this refers to the different brackets or ‘margins’ that constitute the tax liability. For example, the first £12,570 of any cash earned over the course of a tax year is tax-exempt. This is your Personal Allowance. Any money earned between £12571 and £50,270 is subject to a base Income Tax rate of 20%, and any money between £50,270 and £150,000 is subject to a higher rate of 40%.
As a sole proprietor, you will need to consider National Insurance contributions alongside your tax liability. There are four distinct classes for National Insurance, or NI, only two of which apply to freelancers and small businesses. Class 2 NI is a weekly payment of £3.15, while Class 4 NI is a 9% rate applied to money earned above a ‘Lower Profits Limit’ that changes according to government data.
Lastly, there is another ancillary form of taxation that may or may not apply, depending on the structure of your freelance endeavours. Capital Gains Tax is a tax applied to any profits made on the sale of business assets above a Capital Gains Allowance of £12,300. This profit might come from the sale of materials or property linked to your business or the sale of shares bought in a business capacity.