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If you have decided to start your own business as a self-employed sole trader (perhaps having read Choosing the Structure for Your Business) then you might think that you have nothing else to do apart from finding some work and getting paid when you have done it.

Unfortunately it isn’t quite as simple as that, particularly where tax, national insurance and accounting are concerned. In fact if you don’t get on top of your future tax liability you could find yourself out of business just as you thought everything was going well.

Inform the Government

The first thing you must do is register with HM Revenue & Customs (“HMRC”) as being a self employed sole trader. You are legally obliged to do this within three months of setting up your business otherwise you can incur a fine.

Registration is simple. You can register online or you can telephone the Help Line for the Newly Self-Employed on 0845 915 4515.

National Insurance

One of the reasons for registering as self employed is that you will need to start paying National Insurance Contributions (“NIC”) in a different way from if you were employed.

As a self-employed person you will pay the following National Insurance contributions:

Class 2 – This is a fixed weekly amount paid by monthly direct debit or a quarterly bill.
 
Class 4 – This is a percentage of your annual taxable profit from self-employment, which you start paying when your profits reach a certain limit. Class 4 NIC are paid along with your income tax using the Self Assessment tax return.

Taxation

Another reason you have to register is so that HMRC will be able to tax you on the profit you make. As a self-employed person you don’t pay tax on the PAYE (pay as you earn) basis as you would if you were an employee. Instead you must complete a Self Assessment Tax Return (a Form SA103) each year and use this to calculate how much Income Tax and Class 4 NIC you need to pay.

However this doesn’t mean that you only pay tax once a year after and that long after you have completed the tax return.

In the UK the tax year runs from 6th April until the following 5th April. Let’s say that you started your self-employment on 6th April 2008. You (or your accountant) would prepare a set of accounts showing your profit as at 5th April 2009.

You will then have to complete a Self Assessment Tax Return also as at 5th April 2009. However you don’t have to file the tax return (or pay the tax and National Insurance Contributions) until 31st January 2010.

That sound’s good – much better than PAYE – but there is a catch. On 31st January 2010 you not only have to pay the tax and Class 4 NIC for the year ended 5th April 2009 you also have to make a payment on account for the year which will end on 5th April 2010 – even though you haven’t got there yet! Not only that you will need to make a second payment on account for the year ended 5th April 2010 on 31st July 2010

Working Out Your Payments On Account

Very simply, a payment on account is an estimate of what your tax bill will be at the end of your accounting year, based on your previous year’s profits. So if your tax liability for 2009 was £6,000 you will need to pay that plus another £3,000 “on account” by 31st January and another £3,000 by 31st July.

Of course you will also need to bear in mind that your actual profit is unlikely to be the same each year and so if you knew on 31st January that the actual profit at the following 5th April is going to be much lower you can apply to make a reduced payment on account. If you know it is going to be much higher you are not obliged to make a larger payment but you might want to do so rather than wait until the following 31st January to pay the amount underpaid.

You don’t have to start your accounting year on 5th April and you could choose a different year-end. So you might start on 1st October and run your accounts to the following 30th September. However if you do this you will still need to make a tax return as at 5th April as above but the calculation of the tax due becomes a bit more complicated when split over two different tax years when there may be different tax rates and allowances.

These tax issues demonstrate how important it is to have a good accounting system in place so that you always know the profitability of your business and can calculate your tax liabilities throughout the year. There are other good reasons for keeping accounts up to date and you can find out about these by reading the articles below.

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Category: Business Taxation
 

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