If you don’t know how to reduce your tax bill, you may be paying more tax than you need to. We’re here to help you make sure that doesn’t happen next time you complete your tax return.
Tax time isn’t a particularly fun time for anyone, but it can be especially tough when you’re self-employed. The filing process can feel confusing and you’re now facing the reality of how much of your income is going towards your taxes when you file your income tax return.
If you earn a living from being self-employed, there’s no way of getting around the tax that comes with your self-assessment tax return. You can’t avoid it, but that doesn’t mean it needs to break your budget. There’s a lot you can do to reduce how much you pay in taxes and claim back as tax relief, pocketing more of the money you’ve earned.
Let’s take a look at how to reduce your tax bill. Please bear in mind this is a general breakdown of these strategies. It’s always a good idea to speak to an accountant or financial adviser before you make any decisions about your taxes.
- What Are Self-Employment Taxes and Who Needs to Pay Them?
- How to Lower Your Tax Bill
- Make Pension Contributions
- Incorporate Your Business
- Claim All Allowable Business Expenses
- Use Tax Return and Accounting Software
- Make Charitable Donations to Claim Tax Relief
- Claim All Capital Allowances
- Set Up an ISA Savings Account
- Reduce Your Tax Bill When You Pay Tax
What Are Self-Employment Taxes and Who Needs to Pay Them?
Before we cover how to cut your income tax bill, let’s quickly cover what self-employment taxes are and how they work.
Self-employment tax is how sole traders pay income tax, Class 2, and Class 4 National Insurance contributions on their profits to HMRC. You’ll also need to register for and pay value added tax (VAT) if you earn more than £85,000 per year from being self-employed.
You can register for VAT if you earn less than this, and doing so means you can claim VAT on your business purchases. But you’ll need to submit VAT returns to HMRC if you decide to register.
You’ll need to register as a sole trader if you earned more than £1,000 in the last tax year from self-employment. To register, you need to tell HMRC you’re paying income tax through your self-assessment tax return. You’ll also need to file a self-assessment tax return online or by paper each year.
You need to register before the 5th October in your business’ second tax year. So, if you became self-employed between 6th April 2020 and 5th April 2021 (the 2020/21 tax year), you need to register by 5th October 2022.
And you’ll need to file your tax return online or by paper and pay any tax you owe from the previous tax year by:
- 31st October for paper returns
- 31st January for online returns
This means you need to pay tax for the 2021/22 tax year by 31st October 2022 (for paper returns) or 31st January 2023 (for online returns).
You may also need to make your first payment on account—contributions to next year’s tax bill—on these dates as well. Your second payment on account is due on 31st July.
Now you know what sole trader taxes are and how to pay them, let’s jump into the strategies you can use to lower your tax bill and keep hold of more of your income.
How to Lower Your Tax Bill
Make Pension Contributions
If you pay tax at the higher rate of 40%, you can claim tax relief by making pension contributions when you declare your contributions on your self-assessment.
You can claim 20% on pension contributions up to £40,000 per year. And you can backdate claims for up to 3 years, which is useful if you’ve been making contributions but haven’t claimed for these.
As you’re self-employed, you’ll need to get set up with a pension provider by yourself.
Incorporate Your Business
Consider turning your freelance business into a limited company for additional tax relief, with yourself as director. This entitles you to withdraw some of your earnings as dividends, which are tax-free for the first £2,000 and subject to lower tax rates above this. These are:
- 7.5% for the basic rate
- 32.5% for the higher rate
- 38.1% for the additional rate
All tax rates will increase by 1.25% in April 2022 to support the NHS and social care.
You don’t need to complete a self-assessment unless you take out more than £10,000 in dividends.
Claim All Allowable Business Expenses
Make sure you’re claiming expenses for everything you’re entitled to get the most tax relief possible, including:
- Office equipment and costs, such as stationery and phone bills
- Travel costs, such as fuel, parking, and public transport fares (but not your commute to your workplace)
- Clothing costs, such as uniforms
- Staff costs, such as salaries and subcontractors
- Things you buy to sell, such as stock or materials
- Financial costs, such as insurance and financial transactions
- Business premises costs, such as heating, lighting, and business rates
- Advertising and marketing costs, such as your website
- Training costs, such as courses and books
When you use something for personal and business use, you can only claim for the time you use it for business purposes. If your annual phone bill is £200 and £70 of this is for business use, only claim for £70.
And if you work from home, you can claim for:
- Utility bills, such as heating
- Council tax
- Rent or mortgage payments
- Internet and phone usage
But only during times when you’re working or using space for business purposes. If you use 1 of the 4 rooms in your house as a workspace and your total electric bill is £400, you can claim £100 in allowable expenses.
Use Tax Return and Accounting Software
No matter how detail-oriented you are with your receipts, invoices, and expenses, there’s always a chance you’ll have forgotten something. Tax and accounting software can help you spot errors, capture the most opportunities for tax relief, and send a perfect tax return to HMRC.
Software can also help work out where you can save costs and reduce your bill. You’ll see the tax you owe in real time and always be on top of your books.
Make Charitable Donations to Claim Tax Relief
Charity donations to registered charities or community amateur sports clubs (CASCs) are tax-free, and either you or the charity can claim tax relief using Gift Aid. If you pay higher or additional rate tax, you can also claim the difference to the basic rate on Gift Aid donations. Claim any charitable donation you make on your self-assessment.
You might want to set up a standing order to the charity of your choice and make monthly contributions, support friends and family with events and fundraisers, or a combination of both. You can use any of these options to claim tax relief on your charitable donations later.
Claim All Capital Allowances
When you buy and use assets for business purposes, you can claim these as capital allowances—boom, more tax relief. Examples include:
- Vehicles such as cars, lorries, and vans
These are also known as plant and machinery, and you can deduct all or some of their value from your profits before paying tax.
The value will usually be what you paid for the item, unless:
- You owned the asset before you started your business
- The asset was a gift
In this case, you can claim a capital allowance for the market value (the price you’d expect the item to sell for).
Set Up an ISA Savings Account
Individual savings accounts (ISAs) let you save up to £20,000 per year tax-free.
Lifetime ISAs have a £4,000 cap and the government adds 25% to the amount you save. So if you save £4,000 per year, you’ll have £5,000 before adding interest. Despite the name, you can only contribute to a lifetime ISA from ages 18–50.
There are also stocks and shares ISAs where there’s no capital gains tax on the profits. Learn everything you need to know about capital gains tax here.
Reduce Your Tax Bill When You Pay Tax
Self-employment taxes can be a tricky beast. But now you know the best strategies for reducing your tax bill, you can start cutting the amount of tax you owe and keeping more of the income you earn.
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persuasive and engaging copy from Cardiff, United Kingdom. When he's not writing, you'll find him reading, running, and attending rock shows.Greg writes