Tax Obligations as a Freelancer or Self-Employed Creative – All You Need to Know

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There are over 5 million self-employed people in the UK, with a large percentage working as creatives or freelancers within their relative industry.

While being self-employed has many benefits, such as the freedom to work for yourself and better flexibility of your working hours, one of the biggest hindrances is dealing with your own accounting and tax affairs.

The area can appear daunting to many people, especially those who are just starting and are unsure as to where to begin.

In this article, we break down the different tax obligations a self-employed creative or freelancer has in the UK and some of our top tips to stay on top of your financial affairs.

Tax Obligations Depending on Structure

How you manage your tax largely depends on how you conduct your operations.

You could operate as a:

  • Sole trader;
  • Partnership; or
  • Incorporated company.

Most self-employed creatives and freelancers, especially those who are just starting out or yet to pull in substantial profits, tend to operate as sole traders. As a sole trader, you – the individual – are the business, the owner and the manager. A sole trader business has no legal identity separate from its owner and is not recognised as a standalone company.

Alternatively, many move away from the sole trader model and opt to incorporate their business. Typically, registered businesses are formed as a private limited company (LTD) or a limited liability partnership (LLP). However, in most cases, the former is the more widely-used structure, particularly for freelancers and other one-person operations.

I’m a Sole Trader – what taxes do I pay?

As a sole trader, the income you generate from your business operations is counted alongside your personal income. To meet your tax obligations, you must register with HMRC (Her Majesty’s Revenue and Customs) and fill out a Self Assessment tax return each year.

A Self Assessment tax return details your income, gains and relevant expenses for the previous ‘tax year’ – which runs from 6 April to 5 April every year in the UK.

As a sole trader, you are required to pay HMRC the following three taxes:

  1. Income tax – based on your taxable income’ *;
  2. Class 2 National Insurance Contributions (NICs) – calculated at a fixed rate of £3.05 per week in the 20/21 tax year, if your profits are more than £6,475 (no Class 2 NICs payable below this threshold); and
  3. Class 4 NICs – calculated at 9% of profits between £9,500 (no Class 4 NICS payable below this threshold) and £50,000 and 2% on profits above £50,000 in the 20/21 tax year.

* Your taxable income is any income made over the standard personal allowance – which for the 20/21 tax year is £12,500 if you earn up to £100,000. For example, if you generated £35,000 in income, you only pay tax on £22,500 (£35,000 minus £12,500 of your personal allowance). For earnings between £100,001 and £125,000, the personal allowance will decrease by £1 for every £2 of income over £100,000. For earnings of over £125,000, there is no personal allowance.

The amount of income tax you owe will depend on the tax band you fall in. For the 20/21 tax year, this stands as below:

Tax Bands Rate
Earnings below personal allowance (£12,500) No income tax payable
Basic rate (£12,501- £50,000) 20%
Higher rate (£50,001- £150,000) 40%
Additional rate (Over £150,000) 45%

You must pay any tax you owe by 31 January following the end of the tax year. You may also be required to make twice-yearly ‘payments on account’, which effectively act as advance payments for the current tax year.

There is a tax exemption of up to £1,000 a year – which means you can earn up to that amount without notifying HMRC. However, it is a good idea to do so as it may make you eligible for other reliefs you could be entitled to. If your gross trading income is over £1,000, you must notify HMRC via a Self Assessment tax return, even if you don’t expect to pay any tax on your income.

Additionally, if you employ others within your business, you must collect the right amount of income tax and NICs from their pay and pay these to HMRC. To do so, you will need to operate a Pay As You Earn (PAYE) payroll scheme. However, most freelancers and creatives work as a one-person band, so payroll considerations are usually not needed to be taken into account.

I Have a Limited Business – what taxes do I pay?

Many freelancers and creatives choose to set up a company in their name instead of operating as a sole trader. While the nature of operations may remain the same, the tax obligations and schedules for a limited company are different from those of sole traders.

In a limited company setup, you would be regarded as a director, which for income tax and NICs purposes is treated the same as an employee, requiring you to make the relevant payments to HMRC. But unlike a sole trader business, there are ways to ensure you are more tax-efficient. While sole traders must pay income tax on profits above the personal tax-free allowance, limited companies instead pay corporation tax – on all taxable income.

The benefit of this structure is the ability to minimise your income tax and NICs by taking a portion of your remuneration as a salary and the rest as dividends (only if you have available profits).

There is no income tax or NICs due for a salary of up to £8,632 per year, while here is no corporation tax payable on dividends for the company, although the director pays income tax on dividends received, which will have a corporation tax deduction of £1,640 (£8,632 x 19%).

If you, the director, have used up your Personal Allowance and the tax-free dividends allowance of £2,000, any further dividends you receive will be taxed based on your tax band (known as your marginal rate). The rates of tax are lower than normal income tax rates, which is why it’s the recommended way to extract money from your business and pay yourself.

The rates are as follows:

Tax Bands Rate
Basic-rate taxpayers 7.5%
Higher-rate taxpayers 32.5%
Additional-rate taxpayers 38.1%

A structure such as this may seem complex – we get it – however, with some careful planning and consideration, you can keep more of your hard-earned money by employing a tax-efficient pay structure. A typical way to minimise your income tax and NICs as a limited company is to:

  1. Pay yourself a director’s salary up to the Class 1 National Insurance Primary Threshold. No income tax or NICs are due on earnings below this limit; and
  2. Take dividends out of the company to top up your salary. You will pay the lower income tax rates on any earnings above £2,000.

As a limited company, you also have the option to leave surplus income in your reserves to withdraw or invest at a later stage. This is especially beneficial if withdrawing all your profits in any given tax year puts you in a higher tax band. Sole trader businesses are unable to manoeuvre in such a way and must pay income tax and NICs on all profit in the same tax year it is generated, irrespective of whether it has been taken as income or left within the business.

There are several factors to consider when deciding whether to employ a sole trader or limited company set up, including how losses are dealt with, liabilities, pension, accounting standards and more. However, the tax benefits of turning your sole trader business into a private limited company are clear if you turn a profit.

Final Words

Whether you choose to continue as a sole trader or make a move to a limited company setup, the two key aspects to remember are:

Make sure you keep proper records, are fully compliant and file & pay your taxes on time; and
Take advantage of any generous tax schemes and breaks available to you.

Of course, with your time better spent on things that further your development or career, it’s helpful to get advice and speak to a professional regarding getting your affairs organised in the most tax-efficient way possible.

Our previous blog provides some of our most valuable tips for entrepreneurs, freelancers and other self-employed individuals who are still finding their way in the business world and may be struggling to get their finances in order.

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