Financial Planning

Can self-employment help you save on tax?

Can self-employment help you save on tax?

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult an independent financial adviser.

The idea of “striking out alone” – working for yourself – is highly appealing to many people. No more boss to answer to, and you can organise your own time as you like. You can build your lifestyle as you see fit. There could even be the chance to earn more and possibly save on tax. However, does this ideal match the reality?

Below, our financial planning team shows the pros and cons of self-employment from a tax saving perspective – factoring in changes ushered by the COVID-19 pandemic. We hope you find this content useful. If you want to discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:

020 8366 4400 or enquiries@cedarhfs.co.uk

 

Overview

Increasingly, people are turning to self-employment; up from 3.2m in December 2000 to 4.3m today. The primary benefit, of course, is the freedom to “be your own boss” and steer your business in a direction that you want. The downside, however, is that your income is uncertain compared to a regular paycheque. There is the risk that your business might fail, and the hours can be long – especially in the first few years.

There are also tax implications when going self-employed. Before, your tax may have been largely dealt with on your behalf, by your employer, through the PAYE system (pay as you earn). Now, you will need to fill out a regular Self Assessment, submit by the deadlines and possibly work with an accountant to make sure all the right boxes are ticked. With this said, there can be some great tax advantages to going self-employed.

 

National Insurance

When you are employed, both you and your employer need to pay National Insurance (NI). Quite often, the amount you pay ends up being higher than a self-employed person, especially when expenses are factored in. The rate of NI contributions paid by the self-employed pay is 9%, compared to 12% paid by employees. However, there is some concern that the Chancellor may target this discrepancy in the future and raise the former’s contributions.

 

Team up

If you are willing to share ownership of your business with a capable, trusted person – such as your spouse, or a good friend – then this can lead to strong tax savings. This is because each of you is taxed individually on the split of business profits. Here, you could distribute the profits of the partnership in the most tax-efficient way. 

 

Expenses

In 2021-22, more employed people have been able to claim generous tax reliefs due to home working (under COVID-19 rules). Here, you can claim tax relief on £6 a week without needing evidence, like receipts. However, self-employed people can claim expenses provided they can demonstrate these are “wholly and exclusively” for the business. They do not need to be seen as “necessary”. Since self-employed people only pay income tax on their profits (i.e. the income retained after expenses), this has the potential to produce a significant tax saving using careful planning with your accountant.

 

Consider a partnership

Two self-employed people could, of course, run a shared business. Alternatively, you could formalise things in a Limited Liability Partnership (LLP) for extra protection and, possibly, more tax savings. Doing so allows you both to choose how much to draw from the business directly as income, and how much to take as dividends.

For instance, imagine you earned £40,000 as an employed person. Here, £12,570 would be tax-free under your Personal Allowance, but the rest would be subject to 20% Basic Rate income tax (i.e. a £5,486 tax bill). However, suppose you earn this as a member of an LLP. In this case, you could take, say, £12,570 as a salary, pay the NI contributions and take the rest (after corporation tax) as dividends. The latter, at the time of writing, are subject to lower tax rates compared to income tax: 7.5% for Basic Rate taxpayers instead of 20%, and 32.5% for Higher Rate taxpayers compared to 40%.

 

Tax reclamation after loss

It is normal for newly-formed businesses of the self-employed to make a loss in the first years. Did you know that your losses in the present tax year can be carried back, set against income earned (e.g. during employment) during the prior three tax years? This includes tax already paid, even that paid via PAYE. 

 

Conclusion

Whilst there are many benefits to going self-employed, this course is not right for everyone. You lose paid holidays, pension contributions from your employer and need to shoulder the extra burdens involved with being a business owner (e.g. managing accounts, marketing, managing clients and so on). 

Think carefully about the impact on your lifestyle and whether working for yourself would fit your goals, values and personality. It can be especially challenging to start a new business as a new parent, for instance. It can also be daunting “going solo” with no prior contacts or experience. Here, it can help to build up your own network whilst employed, ready for when you do go alone.

Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:

020 8366 4400 or enquiries@cedarhfs.co.uk

 

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