What if you could make money from your hobby? Good news! Plenty of businesses and side projects are born out of simple hobbies and interests. You may also benefit from the tax free trading allowance.
What is the tax free trading allowance?
Starting a side business based on a hobby is a good way to test out whether the entrepreneurial life is for you, and whether your hobby is profitable. The good news is that what you earn on the side could be subject to tax relief. HMRC introduced a tax free allowance to cover “self-starters” with small, hobby-based businesses.
The trading allowance means that the first £1,000 you earn (gross, before expenses) is tax free.
You don’t have to pay anything on this income or even report it. There is also a £1,000 allowance for property income for those who let out rooms or homes.
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What if I earn more than the tax free allowance?
If you earn more than the tax free allowance then you’ll need to register for Self Assessment and pay tax on any profits. You’ve got two choices from then on:
Deduct allowable expenses from your gross income, like businesses usually do, and pay tax on the profits that are left.
It’s up to you which one you choose, but you can only use one method at a time. You might want to work out which one is most tax efficient for you.
If you total all of your expenses, and they are less than the trading allowance, using your trading allowance against tax will be more beneficial.
Should I turn my hobby into a business?
Doing something you love as a business is a completely different experience to doing it for fun. Running a business means taking into consideration profitability, expenses, tax, marketing and admin, on top of whatever you’re planning to sell. Plus, if your motive is to sell things to make a profit, or your sales are consistent or ongoing, then you may need to pay tax on what you sell.
We know it sounds a bit scary, but that doesn’t mean that it’s impossible. As online accountants, we’ve put together some advice on how you can turn your hobby into an HMRC-compliant business start-up.
Log all of your business transactions
When you start to do regular work it’s important to log all your transactions down so that your income, and therefore tax, is clear and accurate.
With simple bookkeeping software like Pandle, this is as easy as linking up your bank account as transactions will be pulled over automatically. We recommend opening a separate business bank account, too. This makes it much easier to differentiate between business and personal transactions.
Claim your allowable expenses
When you start to pay tax, you can reduce your tax bill by claiming for expenses. A percentage of your profits will be taxed (usually by 20%). If you’re spending some of that profit back on the business, it’s not considered profit in the eyes of HMRC. You can deduct the amount you spend on expenses from your profit figures, and therefore reduce the amount you’ll owe in tax.
An example of how expenses work against tax
A hairdresser charges £20 to colour someone’s hair. The hairdresser spent £5 buying the dye. This means that the hairdresser has made £15 in profit. They will pay income tax (at 20%) on the profit. The hairdresser will therefore pay income tax on £15 (£3 tax) rather than on the full £20 (£4 tax). In some cases this difference can be really very significant!
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Choosing between being a sole trader or a limited company
Tax returns can be simpler if you’re a sole trader with a small operation. This will suit most hobby-based businesses. However, some people prefer the limited liability of a limited company in case of debts going wrong, and the ability to nominate multiple shareholders and pay dividends.
We would always recommend seeking a professional to handle your tax affairs for peace of mind and to free up your time from navigating accounts and tax law. An accountant can help you become tax compliant, and also tax efficient so you can save some money!
If you would like specialist advice and for someone to manage your accounts, use the live chat button on screen, or get an instant online quote.
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About The Author
I'm an AAT and ACA qualified Chartered Accountant with over 13 years experience working with businesses, contractors and sole traders. I also love watching live music, and quizzes!
Learn more about Dean.