If you’re planning or have already started a new business, welcome to the business world! Now is a very popular time of year to finally make the leap from employee to entrepreneur, with all those New Year’s resolutions underway.
The early days of a business are an exciting time. You can’t wait to get started and set up shop, ready for all your new customers and profits to come rolling in.
Without wanting to burst anyone’s bubble – there are a few important matters you need to cover before you start selling your wares and promoting your business.
“Nothing is certain except for death and taxes.” While we can’t help with the first one, we’d like to help you get to grips with your tax responsibilities so you’re not caught out.
Unfortunately, taxes are not something you can really ignore or save until later. If you do, you’ll find your dream of running a successful business is dampened by HMRC investigations and hefty fines.
So, we put together this guide to help you get clued up and off to a good start.
Income tax and Personal Allowances – for sole traders
The type of taxes you’ll have to pay largely depend on what type of business you’re starting. Most people will either choose a sole trader or a limited company set up.
If you plan to register as a sole trader (trading just as yourself), you will need to pay Income Tax. This is the same kind of tax you pay as an employee through PAYE. However, the tax that you owe will not be automatically deducted – you will have to do that yourself.
Any tax you owe will first be subject to your Personal Allowance, which for 2018/19 is £11,850. This will rise to £12,500 in April 2019. You can earn up to this amount and not pay any tax.
If you earn over the Personal Allowance, you will have to pay the basic rate of 20% Income Tax. For those earning more than £46,350 per tax year, this rate goes up to 40% and 45% for those earning over £150,000. In April, you’ll only have to pay the 40% tax rate on income over £50,000 – so you could see yourself paying less tax come springtime.
There is also a relatively new tax law that allows you to earn up to £1,000 tax free as a “trading allowance”. This is particularly handy for those who have a day job and start their business on the side. However, those claiming for the trading allowance will not also be able to claim for regular business expenses too.
So, you will have to weigh up whether it’s worth it for the year overall. E.g. if you expect to spend £2,000 on the business over the course of a year, then you’re better off claiming for expenses than the trading allowance.
National Insurance Contributions
For a self-employed person, you will be expected to pay both Class 2 and Class 4 NICs, depending on your income. Class 2 is a flat rate of £2.95 a week but you won’t have to pay it if you earn less than £6,205.
Class 4 is based on a 9% of your profits for those earning between £8,424 and £46,350. Over £46,350 it’s 2%.
Corporation tax – for limited companies
If you choose a limited company over a sole trader, the main difference is that you will have to pay Corporation Tax. Corporation tax is paid at a rate of 19% of all profits for most companies.
In order to pay it you must prepare and submit a Company Tax Return, which is slightly more complicated than just a basic sole trader Self Assessment tax return. We’d recommend you get professional guidance with this if you’re unsure.
If you expect to make more than £85,000 a year you will need to register for VAT. This means that you’ll have to add a rate of 20% onto whatever you sell.
However, if you sell things like children’s car seats or home energy, you’ll only have to charge the reduced rate of 5%. Some things are exempt entirely, such as most food and children’s clothes.
How much VAT you’ve charged and how much you’ve paid through business-related goods/services must be reported to HMRC. This is usually done every 3 months.
If you have charged more VAT than you’ve paid, then you will be expected to pay the difference. If on the other hand, you’ve paid more than you’ve charged, you can reclaim this difference from HMRC.
Soon the way your tax returns are reported will change for VAT-registered businesses. So if you’re VAT registered, you will have to submit digital quarterly returns from April 2019 onwards. You can find more information about Making Tax Digital here.
Paying yourself a salary
Paying yourself as a sole trader is a simple matter of withdrawing money from your business funds. Things are a bit trickier for limited companies because you are technically a separate entity to your company.
As a director, you can pay yourself a salary which you must then pay Income Tax on, the same way as if you were employed or a sole trader.
We know what you’re thinking. First Corporation tax, now Income Tax – seems like a whole lot of tax, right?
Luckily, there are some (perfectly legal) ways to reduce your tax bill. We’re not talking about dodgy dealings or offshore accounts here. We’re just referring to simple ways to ensure you’re not paying more tax than you have to.
One way to reduce your Income Tax bill is to take a small salary and make the rest up as dividends. This means you can take advantage of both the Personal Allowance (£11,850) and also the dividend allowance (£2,000) before you need to pay tax. That’s £13,850 tax free earnings!
Another reason to use dividends is because the tax on dividends is lower than regular Income Tax. The basic rate is 7.5%, rising to 32.5% for higher rate and 38.1% for the additional rate. Compare this with 20% basic rate Income tax, 40% higher and 45% for the highest.
Claiming for expenses
Claiming for expenses can help you reduce your Income Tax bill if you’re a sole trader, and also your Corporation Tax bill if you run a limited company.
But how do they work? Essentially, any money you receive that you spend back on the business is not profit, it’s an expense.
Income – expenses = profit
E.g. you shouldn’t be taxed 19% Corporation Tax on that £50 you spent on office stationery because that money isn’t profit. You need it to run the business.
Reducing your profit figure means you’ll be paying less tax, so it’s important to claim for your expenses to keep costs down. A few pens here and there may not seem important enough to record, but those figures can add up over a year.
Recording all your expenses gives you a clearer view into your cash flow too, so there are no nasty surprises – you know exactly where everything is going.
With bookkeeping software, it’s really simple to record your expenses. You can even link up your bank account in some cases so it’s all done for you.
Registering for Self Assessment
Most self-employed people, or those earning money through property or dividends, will need to complete a Self Assessment tax return each year. In it, you must report all your earnings and expenses to HMRC.
If you haven’t registered for Self Assessment yet, it’s easier than you think because you can do it all online. You’ll need to do this by October 5 in the second tax year of your trading period.
E.g. if you start trading in January 2019, you’ll need to file for the 2018/19 tax year. The deadline would be October 5 2019, which is in the company’s second tax year.
Once you register, you’ll receive your Unique Taxpayer Reference (UTR) which you must keep hold of to use HMRC’s online services or if you hire an accountant to help you.
Submitting your tax return
When you have registered, you will have until January 31 to submit your tax return and pay the balance you owe.
HMRC will calculate what you owe based on figures you provide so it’s important they are accurate and the expenses you’re claiming for are fair and solely for the business.
If anything seems unusual, HMRC may decide to investigate your finances. If this happens, you will need to submit evidence for all your income and expenses which can be a long and stressful process.
Getting ahead and saving you stress
We would strongly recommend getting everything tax-related done and dusted way before the deadlines. There’s less chance of forgetting or misplacing information and more chance your accountant will have adequate time to complete your accounts in time.
You don’t want to be one of the millions of people every year who forget and spend the start of the year scrambling around trying to find receipts and transactions from a year ago.
January is a very stressful and busy time of year for accountants because a lot of people leave everything to the last minute. So, please be kind to your accountant and also save yourself from the stress!
Do you have any questions about business taxes? Are you looking for low-cost accountancy services? Get a free quote here.