Self-employed tax demystified

  • From the series Proposals for Everyday Living by Alastair Levy (Photography, 200

Income tax for self-employed people can be daunting if you have never done it before. But it is actually very simple, unless of course you have vast savings stashed away in some offshore account or complicated hedge funds. But let us assume – for this year at least – that these are not an issue for you. Here is how to work it out.

How Self-Employed (Sole Practitioner) Tax Works

The amount of tax you will pay is worked out as a percentage of your income. The following example shows how you would calculate your tax, using 2010 figures:


Gross income (the money people pay you for your work) £30,000
The costs of running your business -£7,200
Net income (your profit, after deducting business costs) £22,800
Personal Allowance (this can change annually - see -£6,475
Taxable income £16,325


The Personal Allowance is the total amount a person is entitled to earn every year without paying any income tax on it. Above this figure, your income is taxed at 20 per cent. Since 20 per cent of £16,325 is £3,265, this is the amount of tax you would have to pay. You pay in two goes: by 31 January and 31 July every year, so in this case you will need to have saved two lots of £1,632.50.

National Insurance

As well as tax, you will have to pay National Insurance (NI). National Insurance payments go towards creating a state pension for you. There are four classes of NI, and self-employed people must pay two classes: Class 2 and Class 4. Class 2 National Insurance contributions are paid at a small weekly flat rate. Class 4 National Insurance contributions are paid as a percentage of your annual taxable profits – 8 per cent on profits between £6,475 and £43,875, and a further 1 per cent on profits over that amount.  In the illustration above, the amount of Class 4 you have to pay is thus £22,800 less £6,475 = £16,325 x 8% = £1,306.  If you now add this to the amount you owe in tax, it comes to £4,571.  As with the tax, you pay Class 4 NI in two goes, at the same time as the tax.  So if your total tax and NI liability is £4,571, you’ll have to pay two lots of £2,285.50, one by 31 January, one by 31 July.

How much to set aside?

You will need to save this money so it is available when the time comes to pay it. It is a good plan to open a building society account and get into the habit of putting the money aside. You are not in the comfortable position of some employees, who have an accounts department down the corridor creaming off the top of their monthly income for tax and NI. You have to be your own accounts department. So it is important to know how much of your precious £30,000 gross income you need to put aside every month to build up your tax and NI fund. The calculation is easy:

£4,751 ÷ £30,000 x 100 = 15.23 per cent

Self-employment: The financial issues

When you start trading (defined as when you issue your first invoice) you have two months in which to register as self-employed. If you do not register during this period you are liable for a penalty. The way to become officially self-employed is to register with the Inland Revenue. Assuming you are basing your business at home to begin with, go to the HM Revenue & Customs (HMRC) website and follow the links.

It is a good idea to find an accountant, to help you on the road. You may wish to ask for recommendations from friends, family, your bank and your contemporaries in the creative arts. You want someone who deals with small businesses and creative people, rather than someone who is used to corporate mergers and acquisitions. Once you have selected an accountant, ring them up and ask for a free first hour with them. Most accountants will do this, in the hope that you will become a regular customer. Before you meet them, outline your basic financial position on a side of A4 (savings, debts, outgoings, income, etc.) and email it to them. That way, you will not spend most of that precious hour trying to remember the details of your finances. Prepare for success!