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If COVID-19 has you reassessing your career path, but you’re not quite ready to quit your regular job yet – you’ve come to the right place. This bumper article contains a wealth of handy information about how to kickstart a freelance career while balancing a regular full-time job.
(If you want to find out what support is available to businesses during the pandemic, check out our COVID-19 Hub.)
Contrary to popular belief, the terms ‘employed’ and ‘self-employed’ are not opposites. In the strange world of HMRC, it’s possible to be employed and self-employed at the same time – in fact, it’s actually pretty common. But what implications does working on the side have for your freelance tax liability?
If you’re considering making a bit of extra money by working for yourself on top of your main job, read on for everything you need to know, including what self-employed tax and National Insurance you’re expected to pay, and how to pay them.
Don’t have time to read this article now? Why not download a PDF version and read it over a cuppa later?
There are various reasons why someone might want to be employed and freelance (as self-employed) at the same time. Some may want to earn a little more. Others may be more entrepreneurial – many small businesses are started by people in full or part-time employment.
Whatever your reasons, you need to know that there’ll be some tax issues for you to think about – so let’s get to the nitty-gritty.
All the figures in the following example are based on the HMRC published rates and thresholds for the 2020/21 tax year.
Your Income Tax is always calculated on total earnings, so you’ll have to pay tax on amounts above the Personal Allowance for your combined income from employment and sole trader profits (from self-employment). We’ll talk about the difference between income and profits a bit later.
It’s important to realise that if your sole trader profits push your total earnings into a higher tax band, you’ll have to pay the higher rate.
An example for the 2020/21* tax year:
|Income from an employer||£35,000|
|Profits from sole trade (self-employment)||£20,000|
|Total taxable income||£42,500|
|Income Tax paid at basic rate (20%)*||£7,500|
|Income Tax paid at higher rate (40%)*||£2,000|
|Total Income Tax paid||£9,500|
*for 2020/21, there are different income tax rates for Scottish residents
You’ll pay income tax of 20% on all earnings above your personal allowance and below the upper limit of the basic rate, which is £37,500 for the 2020/21 tax year. You’ll pay income tax of 40% on all earnings above the basic rate limit until you reach the higher rate limit (which in the 2020/21 tax year is £100,000). In this example, you pay 40% tax on the income of £5,000.
When you prepare your annual Self Assessment tax return, you will disclose the tax already paid on your earnings from your employer (in this example £35,000 would have been taxed under PAYE arrangements). So HMRC will know you have already paid tax on part of your total income. The amount of tax you pay on your profits from self-employment (£20,000 in this example) will be worked out by HMRC when you submit your Self Assessment. You can find out more about how to complete your first Self Assessment in our handy article.
Check out our tax rates and thresholds article for more information on the UK Income Tax rates.
The National Insurance you pay on your income from your employer won’t change, but it’ll be a bit different for your income from self-employed profits.
Firstly, if your self-employed profits exceed £6,475, you’ll have to pay a flat rate of £3.05 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 directly to HMRC through a direct debit, which you can register for online at Gov.uk. We’ve got an article with all the information you need on how to register as self-employed, including who you need to contact and when.
If you’re doing well, you may also have to pay Class 4 National Insurance. This is charged at 9% for all self-employed profits between £9,500 and £50,000, and at 2% for all profits greater than £50,000.
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||£20,000|
|Class 2 National Insurance
(52 weeks @ £3.05 per week)
|Class 4 National Insurance
(9% on profit between £9,500 and £50,000 – in this example the profit is only £20,000 so 9% * £10,500)
|Total National Insurance paid||£1,103.60|
Remember, you’ll have your Class 1 National Insurance to pay too, through PAYE deductions made by your employer for your paid employment, you can find details on the gov.uk website.
The basic difference is that if you’re a sole trader then there’s no legal separation between you and your business. You’re personally liable for all activities of the business, including debts.
If you form a limited company you create a separate legal entity and you have no personal liability. However, you’ll have specific legal and statutory responsibilities to fulfil as a director of the company. This also has a number of tax implications.
Read more about the differences between sole traders and limited companies.
One of the main benefits of registering as self-employed as a sole trader is that you get to offset your business expenses against your income. You’re only taxed on your self-employed profits.
There’s a similar situation for limited companies – where Corporation Tax is only paid on company profits after allowable expenses. These can include salary and pension contributions as well as certain travel and subsistence expenses.
What exactly is considered to be an allowable expense and how to claim is a complicated affair, so we won’t get into that here. Instead, take a look at our article on sole trader expenses or our article on limited company expenses, and bear in mind the “wholly and exclusively” rule (i.e. anything you claim as a business expense must be entirely for business use).
The Crunch Personal Tax Estimator can help you to plan for the tax you may have to pay on your personal income including sole trade income, salary and dividends if applicable. You can read our Personal Tax Estimator article and download our calculator to try it out.
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 new business.
It’s a legal requirement to register with HMRC as a new business if your earnings as a self-employed sole trader are more than £1,000 in a tax year.
If you’re already employed full-time, this may happen as soon as you receive your first self-employed income. Once you have earned more than £1,000, you’ll have until 5th October after the end of the tax year to register as self-employed and register for your annual Self Assessment or risk paying a fine. You can get in touch to let them know by using this simple form on HMRC’s site.
However, if you are unlikely to earn over £1,000, you don’t need to file a Self Assessment as HMRC has introduced the £1,000 trading allowance to remove the need for filing a return in such circumstances. Find out more in our article.
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, especially if there is a risk of competition with your current employer.
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 form a limited company your details are publicly available at Companies House, so your employer could find out about your business that way.
Of course, we’d never recommend that you mislead your employer. However, it’s possible to start outside work without disclosing it. Just be aware that you do so at your own risk.
Our article ‘How to set up a small business while working on the side’ will give you practical tips on taking those first steps.