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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 deciding to freelance on the side 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.
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.
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
Profits from self-employment
Personal allowance for those born after 5 April 1948
Total taxable earnings
Tax paid at basic rate (20%)
Tax paid at higher rate (40%)
Total tax paid
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.
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
Class 2 National Insurance (52 weeks @ £2.75/week)
Class 4 National Insurance (9% on earnings over £7,775)
Total National Insurance paid
Remember, you’ll have your Class 1 National Insurance to pay too, which you can find details on here.
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.
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).
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.
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.
You might avoid a fine if a close relative died shortly before the self assessment deadline, you've been seriously ill, or if you had major IT problems.