If you are self- employed then no-one is deducting tax from your income every month as they would be if you were employed, so you need to discipline yourself to put money aside yourself for your tax bill.
But how much should that be?
The general rule is that as the basic rate of income tax is 20%, and the NI that the self-employed pay (class 4 NIC) is 9%, then putting aside 25-30% of your income to cover your tax bill makes sense. And in a lot of cases this is true. If you end up having put too much aside, then happy days – you have some unexpected cash!
But in some situations the 30% guide may not work:
If your income isn’t that high:
Everyone has a personal allowance which is the amount of income that you can earn before you start to pay tax. This year the personal allowance is £12,570 so if your total earnings are around this amount, then you will only have a small amount of national insurance to pay and putting 30% aside would be excessive. It might mean that your business has been short of cash during the year as you have been frantically saving more than you needed to and you could have put the money to good use in your business.
If you have other income outside your self-employment:
If you have other income of around £50k in the year, then any profit from your self-employment is going to be taxed at 40% rather than 20%. You may also need to make a payment on account of your tax bill during the year- so you should probably be putting aside 50-60% of your earnings each month to cover your tax bill.
If you have just started trading:
If you have just started trading and your business is generating decent profits from the start, then you could be straight into payments on account (see other blogs for more details about these.) This could mean that your first tax bill in January is increased by 50% to cover your first payment on account, and you also need to put an additional amount aside to cover this.
So in general it is definitely sensibly to put money aside each month to cover your tax bill. Don’t think that you can cover your tax bill from money that you will earn in the future – this last 18 months has definitely shown that we never know what the future will bring!
Also remember that you pay tax on your profits and not your sales figure. So having an idea of what your profit is each month will help in determining how much you should be setting aside. Using accounting software will give you this information and help you manage your cashflow and save for tax.
These figures are for general guidance only and it is always best to get personal tailored advice.
For any further information or help with your personal tax returns, then please contact Rosie Forsyth.