Self-employment can bring a range of benefits, but it also comes with obstacles – some of which involve your taxes. When you’re going it alone, looking after your pennies is essential. So how can you reduce your tax bill?
If you’re looking to cut down on your taxes and avoid penalties for doing so, you need to understand how you can make your finances work for you. To get you started, we’ve rounded up these five ways to lower your tax bill for the self-employed.
You may know that you can list expenses on your tax self-assessment form, but are you taking full advantage of it? If not, you could be missing out on tax relief offered by HMRC for a range of work-related costs – so it’s a great place to start cutting down your bills.
If you’re new to self-employment, you might not realise how much of what you spend can be claimed for as expenses. Most self-employed workers will list expenses such as office equipment, travel and financial costs such as bank charges or insurance. If you’re a larger business with staff or premises, you might be able to claim for those, too.
There are rules around what you can and can’t claim for, and this is where you need to calculate carefully or risk facing penalties. You must only claim for expenses that are entirely business-related costs – not personal. For example, if you work from home, you can’t claim for your whole electricity bill – you must calculate the costs for the time you actually spent working.
When you’re self-employed, it’s up to you to set up your own pension scheme – and doing so can earn you tax relief. If you pay basic rates, every £100 you deposit into your pension will be boosted by £20 of tax relief from the government. Higher rate taxpayers get 40% tax relief, and if you pay additional rates, you’ll get £55 added to your pension per £100 put in.
The rules in Scotland are slightly different, as the tax bands used to categorise taxpayers are altered. If you pay 19% or 20% rates, you’ll get £20 of tax relief. For taxpayers who pay 21%, 41% or 46%, the amount of tax relief you’ll get per £100 deposited is £21, £41 and £46 respectively.
If you make enough profit to pay tax at the higher rate of 40%, then listing any charitable donations on your tax return could reduce your tax bill. This goes for those who pay the higher rate in Scotland, as well. You can claim back the difference between your tax rate and the basic rate that’s applied to your donation.
For example, if you’re a higher rate taxpayer and you donate £100 to a charity using gift aid, you can claim back £25. This is because the charity gets an extra 25% from the government through the gift aid scheme, making the total donation £125. You pay 20% on top of the basic rate, so you can claim back 20% of the donation, which is £25.
Have you considered incorporating your business? Although it sounds official and complicated, it’s actually quite simple – it just means you register your business as a limited company and you become its director. This gives you the opportunity to reduce your taxes.
Company directors are allowed to withdraw some of their earnings as dividends – and this is free from tax up to a threshold of £2,000. After this, you’ll need to pay tax, but at much lower rates than your self-employment income tax. For income tax rates of 20%, 40% and 45%, you can expect to pay rates of 8.75%, 33.75% and 39.35% respectively.
Self-assessment software can help make planning your taxes much easier, with tools that allow you to analyse your finances, calculate your tax liability, and get updates in real time. Some tools can even help you save money on your tax bill by highlighting tax-deductible expenses you can claim for.
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