Contrary to popular belief, the terms ‘employed’ and ‘self-employed’ are not antonyms. In the strange metaphysical realm of HMRC it is possible to be employed and self-employed at the same time. In fact, it’s actually pretty common.

But what implications does this have for your tax liability? If you’re one of the UK’s growing number of part-time freelancers, read on for everything you need to know about paying your tax.

Why freelance on the side?

There are various reasons why someone might want to be employed and self-employed at the same time. Some might want to earn a little more than what they get from their employer. Others might be more entrepreneurial – many small businesses are started on the side by people in full or part-time employment, and later grow to become full-time endeavours.

Whatever your reasons, you need to know that there will be some tax issues for you to think about. The government plans to raise £9bn over the next five years from clamping down on tax avoidance, so it’s really important that you’re up to speed.

So let’s get to the nitty gritty.

Moonlighting

How much income tax will I pay?

Income tax is always calculated on total money earned, so you’ll have to pay for any earnings that exceed the personal allowance on your combined employed income and self-employed profits. We’ll talk about the difference between income and profits a bit later.

It’s important to realise that if your self-employed profits push your total earnings into a higher tax band then you’ll have to pay the higher rate on that chunk.

An example for the 2014/15 tax year:

Income from employer

£35,000

Profits from self-employment

£10,000

Total earnings

£45,000

Personal allowance for those born after 5 April 1948

£10,000

Total taxable earnings

£35,000

Tax paid at basic rate (20%)

£6,373

Tax paid at higher rate (40%)

£1,254

Total tax paid

£7,627

You will pay 20% tax on all earnings exceeding your personal allowance and below the upper limit of the basic rate, which is currently £31,865. This includes all your income from your employer and £6,865 of your profits from self-employment. You will pay 40% tax on all earnings above the lower limit of the higher rate, in this case, on £3,135 of your profits from self-employment. The amount you pay on the income from your employer will be worked out using PAYE.

The amount you pay on your profits from self-employment will be worked out using an annual Self Assessment tax return, which can be filled out online here.

What about National Insurance?

The National Insurance you pay on your employed income won’t change, but it will be a bit different for your self-employed profits.

Firstly, if your self-employed profits exceed £5,885, you’ll have to pay a flat rate of £2.75 per week. This is called Class 2 National Insurance.

You usually pay Class 1 National Insurance through PAYE via your employer, but Class 2 is paid direct to HMRC through a direct debit, which you can register for here.

If you’re really doing well for yourself, you may also have to pay Class 4 National Insurance. This is charged at 9% for all self-employed profits between £7,956.01 and £41,865, and at 2% for all profits greater than £41,865.

Just like your Income Tax, Class 4 National Insurance contributions will be worked out on your Self Assessment tax return.

Let’s use the same figures from our previous example to demonstrate how this all works –

Profits from self-employment

£10,000

Class 2 National Insurance (52 weeks @ £2.75/week)

£143

Class 4 National Insurance (9% on earnings over £7,775)

£183.96

Total National Insurance paid

£326.96

Remember, you’ll have your Class 1 National Insurance to pay too, which you can find details on here.

Taxes

Sole trader or limited company?

As a self-employed person, you can either choose to operate as a sole trader, or form your own limited company.

The basic difference is that if you’re a sole trader then there’s no legal separation between you and your business. You are liable for all actions undertaken by the business as if you performed them yourself.

If you form a limited company you create a  separate legal entity and decrease the amount of personal liability you have in the business. This also has a number of tax implications. Read more about the differences between sole traders and limited companies here.

What about expenses?

One of the main benefits of registering as self-employed is that you get to offset your expenses to pay a reduced amount of tax. This is because you are only taxed on your self-employed profits, meaning your total self-employed income minus any allowable business expenses.

What exactly is considered to be an allowable expense is a complicated affair, so we won’t get into that here. Instead, take a look at what HMRC have to say, and bear in mind the “wholly and exclusively” rule (i.e. anything you claim as a business expense must be entirely for business use, and for business use only).

Will my employer find out?

Although it usually won’t be a problem, it’s understandable that you might not want your employer to know that you’re working on other projects. Be careful, though, because your employment contract might forbid you to take on outside work.

Your tax affairs are entirely confidential and HMRC will not inform your employer if you also register as self-employed. However, be aware that if you register as a limited company your details will come up on searches of Companies House, so your employer could find out about your business that way.

Of course we would never recommend that you mislead your employer. However, it is possible to start outside work without disclosing it. Just be aware that you do so at your own risk.

When should I tell HMRC?

Although your employer doesn’t need to know, the taxman definitely does! HMRC recommends that you let them know as soon as you start trading from your business.

As far as hard and fast deadlines go, it’s a legal requirement to register with the taxman as a new business as soon as your combined earnings (from your full-time employment and any other work) exceed your personal allowance.  If you’re already full-time employed this is likely to happen as soon as you receive your first self-employed paycheque.

Once this happens you’ll have until October to let HMRC know, or risk paying a fine.

You can get in touch to let them know by using this simple form.

Photos by Steve Davidson & Ken Teegardin

  • szef

    How does paying dividends vs salary for the Ltd change the tax picture?

    • Nick Chowdrey

      Hi szef. Dividends are taxed at a different rate to regular PAYE salary – https://crunchaccounting.zendesk.com/entries/20279586 so if you’re freelancing on the side you could make some savings by setting up your own limited company, paying yourself through dividends rather than salary.

  • http://robynwilder.com/ Robyn Wilder

    Hi, so if you work for an employer and go on maternity, freelancing while on leave doesn’t forfeit your SMP if you declare it to HMRC? Just looking for clarity as I’m receiving lots of conflicting advice.

    Thanks!

    • lesleyfurber

      HI Robyn, I don’t believe it does, but I would check this with the HMRC to be on the safe side. You obviously can’t work at all for the first 2 weeks after you give birth Regards, Lesley, The HR Kiosk

  • Puvan

    That was so helpful and informative! Thanks for the facts without all of the useless jargon :)

    • http://www.crunch.co.uk/ Crunch.co.uk

      Thanks Puvan – glad you found it helpful :)

  • Robyn Elliot

    I would benefit from some advice, please.
    I currently freelance and i am working full time. At the moment I do this for the same company and that company process all of my tax for me through PAYE (it then becomes like a second income).
    I think it would be in my interest to register as self employed with HMRC for my freelance work, but i would still like to undertake this for the company I am employed by. The advice I am being given is that because I am an employee they must process my tax on the freelance work i do for them. Is this the case?

    • http://www.crunch.co.uk/ Crunch.co.uk

      Hi Robyn,

      The company are most likely insisting they process your payroll because if they don’t you could be opening yourself up for IR35 trouble (where HMRC will decide you are an employee even though you are being paid as self-employed) – give this a read and let us know if you have any more questions –

      http://www.crunch.co.uk/guides/ir35-guide/

      • Robyn Elliot

        That’s great. Thanks very much.

    • Suzanne

      My husband has been offered either redundancy or reducing his days from 5 to 3 which he has accepted. He is going to freelance in the other 2 days for different companies. However, if the company he works pt for wanted him to occasionally go in on a freelance basis on the 2 days he doesn’t work for them, is this ok?

      • lesleyfurber

        Hi Suzanne, yes that should be fine. He can be both employed and self-employed at the same time; and his yearly tax return would need to reflect this. Regards, Lesley, The HR Kiosk

  • Natalie

    Hi there, my husband is thinking about setting up a sole trader as well as full time employment. I’m rather confused on the income tax calculation. For example he earns around £26,000 gross and say we plan on profits of £10,000 through this sole trader. Total gross income is £36,000 less the personal allowance of £10,000. Total taxable income is £26,000. Basic rate tax of 20% = £5,200.00. Obviously his employer will be taking income tax from him so will he still need to pay the full £5,200 or is this calculated through self assessment? as I would of thought he would be paying income tax twice. Thank you

    • http://www.crunch.co.uk/ Crunch.co.uk

      Hi Natalie,

      The portion of his income earned through employment will have Income Tax + NICs deducted automatically, the rest of his income he’ll have to pay tax on when he completes his Self Assessment. When he’s filing he can tell HMRC how much he earned through employment, and they’ll take that into account to make sure he uses his Personal Allowance etc.

      It’s a bit of a complicated process – this slideshow might help you get your head around it –

      http://www.slideshare.net/CrunchUK/part-time-freelancing-how-to-avoid-tax-hell-32989137