Updated: Aug 28
Considering the transition to freelancing, whether as a primary source of income or a supplementary endeavor alongside your full-time job, financial aspects hold significant importance. Determining potential earnings and assessing whether freelancing would improve or impact your financial standing in comparison to your regular job becomes crucial. For those contemplating freelance work or already navigating this path and seeking comprehensive tax insights, the following paragraphs provide answers to frequently asked questions concerning taxes and freelancing.
Firstly, a fundamental query emerges: what classifies someone as a freelancer? The answer is straightforward – if you are self-employed, you are a freelancer. Freelancing is merely a facet of self-employment. While many self-employed individuals function as "sole traders," managing their own businesses independently, some opt for limited companies to safeguard them from personal financial liabilities. Notably, as a sole trader, you retain your business profits after settling tax dues on your taxable income.
The question of whether to register as a freelancer arises next. The necessity depends on your taxable income. If your earnings surpass £1,000 within a tax year (spanning from 6th April to 5th April), registering for Self Assessment (the framework employed by the UK tax authority HMRC for Income Tax collection) becomes obligatory upon becoming a sole trader. It is crucial to note that registering for Self Assessment also entails automatic registration for National Insurance. Failing to register for Self Assessment by 5th October of your business's second tax year could result in fines imposed by HMRC.
As a sole trader freelancer, certain responsibilities come into play. Detailed records of both business income and expenses must be maintained. Each year, a Self Assessment tax return (SA100 form) must be completed and filed, along with an additional tax return page (SA103) outlining freelance earnings and expenditures. This process encompasses the payment of Income Tax on taxable profits and any Class 2 and Class 4 National Insurance contributions (NICs) due.
Regarding side-hustles, which denote activities pursued to supplement regular employment, such endeavors are deemed self-employment. Consequently, income from side-hustles could incur taxation if it surpasses £1,000 in a tax year, particularly when regular employment income exceeds the tax-free Personal Allowance (£12,570 for the 2023/24 tax year).
A vital threshold emerges regarding how much freelance income can be earned without necessitating reporting. The Trading Allowance allows for up to £1,000 in freelance income before taxation applies. However, sole traders who claim tax expenses are ineligible for the Trading Allowance, requiring a calculated choice between the two options. Even if taxable income falls below £1,000, registering for Self Assessment might be advisable to pay voluntary Class 2 NICs, thereby ensuring eligibility for specific state benefits.
The tax structure for freelancers involves determining Income Tax based on different brackets. The first £12,570 of income remains untaxed, constituting the Personal Allowance. Subsequent calculations consider Income Tax bands, leading to 20% for the basic rate, 40% for the higher rate, and 45% for the additional rate. Additionally, specific tax-free allowances, such as the Property Allowance, can further influence the overall tax liability. It's worth noting that tax bands and rates differ in Scotland.
National Insurance contributions (NICs) are essential for freelancers. If a self-employed individual's profits reach £12,570 or more annually and they're registered for Self Assessment, they are required to pay Class 2 and Class 4 NICs. For instance, Class 2 NICs amount to £3.45 weekly, while Class 4 NICs comprise 9% for profits between £12,570 and £50,270, and 2% for profits surpassing £50,270.
A common scenario arises when individuals are both employed and self-employed. This combination mandates Income Tax and Class 1 NICs payment through the employer's payroll, alongside Income Tax and NICs (Class 2 and potentially Class 4) for self-employed income through Self Assessment. HMRC calculates these dues post submission of the Self Assessment tax return, considering the overall taxable income.
Tax expenses serve as a crucial aspect for freelancers, as they can significantly reduce the tax liability. These "allowable expenses" encompass a range of business-related costs. Detailed categorization within the annual Self Assessment tax return results in deduction of these expenses from the overall income before tax computation. It is important to ensure accurate calculations and retain evidence for any claimed expenses.
Allowable tax expenses include various items such as raw materials, printing, travel costs, premises expenditures, advertising, insurance, and more. If freelancers operate from home, a portion of household costs can be claimed. Notably, this option must be balanced against flat-rate simplified expenses to ascertain the most advantageous approach.
Furthermore, purchasing equipment like laptops can qualify as allowable expenses, contingent on the chosen accounting method. Food expenses, however, are only claimable under exceptional circumstances, and commuting costs are generally not eligible for claims. VAT regulations are also pertinent. VAT registration is dependent on turnover, and reclaiming VAT applies only to registered freelancers.
In an era of advanced technology, concealing taxable income is unwise. HMRC employs various sources to detect such activities, including advanced software analysis, bank records, and online platforms. Attempts to evade taxes could result in substantial fines and, in severe cases, even imprisonment.
In summary, navigating the realm of freelancing requires a comprehensive understanding of taxation nuances. Whether determining self-employment status, calculating taxable income, or discerning allowable expenses, knowledge of tax implications is pivotal. By delving into these key tax facts, freelancers can ensure compliance, optimize deductions, and make informed financial decisions.