Keep spreadsheets of all income and categorise all expenses.
So, you’ve spent your year as a VDP and now you’re entering the world of the self-employed as an associate. There are all kinds of hoops to jump through to satisfy the Inspector of Taxes. Here’s a quick guide on what you need to do:
1. Register as self-employed
Self-employed people pay two kinds of National Insurance contributions – class 2 NIC and class 4 NIC.
Class 2 NIC is payable at a fixed weekly rate (currently £2.40) and entitles you to claim state benefits such as short-term incapacity benefit and maternity allowance, but also begins to build up an entitlement to a state pension. Class 2 NIC is normally collected monthly by direct debit or paid quarterly by cheque. You must register to pay class 2 NIC within three months of becoming self-employed. Failure to do so will attract a penalty of £100.
Class 4 NIC is paid with the remainder of your income tax and is based upon a percentage of your profits above a lower limit. Class 4 NIC attracts no state benefits whatsoever.
You can register as becoming self-employed by phoning HMRC, registering online at www.hmrc.gov.uk/startingup or by using form CWF1 (found in booklet SE1, along with the direct debit to enable you to pay class 2 NIC).
2. Keep records
You will need to keep all business financial records and private financial papers separate. The easiest way to do this is to open a new business bank account. You should keep all your income summaries from the principal, invoices for services you performed, and receipts for items you purchased for work purposes.
There will also be certain expenses incurred for private and work purposes, the car being the prime example. To claim the relevant work proportion of the expense, it must be clearly identifiable, or no proportion is allowed at all. Therefore, you should keep a mileage log of all journeys to determine the precise percentage that may be claimed for business. The journey from home to the surgery and back is not a business expense.
The better your records, the less it will cost you in accountancy fees. Keep spreadsheets of all income and categorise all expenses. For example, don’t put your phone bills with petrol receipts. Keep a separate note of any money you have introduced to the business for the purchase of, say, a new computer. Also, keep a note of cash you withdraw from the account for your own living expenses.
If you are just starting up and have been employed in the same tax year, you will need to keep your P60 for the employed position, together with the remainder of your personal information, for at least five years and 10 months after the end of the tax year to which they relate.
3. Understand the tax system
For individuals, the UK tax system runs from April 6 one year, to April 5 the next. With the advent of self-assessment you are taxed in your first year of business upon the profits (not the amount you take out of the business account as wages) from the date you start to the following April 5. It is convenient thereafter to keep your accounting year-end date the same as the tax year and be taxed on the profits for the year ended April 5, each time.
To self-assess your tax, you will need to complete a tax return. Paper returns may be completed and filed with HMCR by October 31, following the end of the tax year. HMRC will even calculate your tax liabilities from the information you provide if you file by this date. When filing online, you have until January 31, following the end of the tax year to submit your return. Automatic penalties are imposed if you miss filing deadlines.
The tax and class 4 NIC liabilities for your first period of self-employment become due by January 31, following the end of the tax year. But beware, there’s a catch. As well as the tax and class 4 NIC due for your first period of self-employed work, you also have to pay half as much again in advance for the following tax year. By the following July 31 you then have to pay another half in advance. So, by the time the following year’s tax becomes due the January after that, you’ve already paid a big wedge up-front based upon the previous year’s tax liabilities. When your actual liabilities are then worked out for that following year, you should only have a small balancing payment or repayment due. You will, however, have half as much to pay in advance for the year after that, and so on.
Where you start work early in a tax year, therefore, your first tax bill may be much larger than anticipated, for you will be paying tax on 18-months’ worth of profit rather than 12, because of the 50 per cent up-front payment for the next year.
This makes it important you keep your records up-to-date and pass them to your accountant as soon as possible after the end of the tax year. The sooner you know your liabilities accurately, the longer you have to save up.
For further information, contact Paul on 01253 404404 or e-mail paul.clare@mooreandsmalley.co.uk