I’m often asked by those looking to start freelancing and contracting what they need to from a tax and accounting perspective to get going. There are lots of different ways of doing it, but in order to minimise tax I would do it through a Limited Company (unless you are likely to be impacted by IR35). So here is a simple guide. please note that if you work in construction there are a whole load of other issues ….
- Register as self-employed with HMRC – First off you should tell HMRC (the tax people). You need to register as a self-employed person so that they know that you will be paying tax on an annual self-assessment tax return rather than (or as well as) through Pay as you earn. Here is the relevant HMRC page.
- Register a company – If you are expecting to earn more than about £30,000 a year and expect to do this for more than one year then the best thing to do tax-wise is register a limited company and trade through that (see details about tax below). Registering a company is becoming absurdly simple and cheap recently. Just do a quick google search for Company Formations and you will see lots of options. Unless you are getting the formation alongside advice from an accountant you really shouldn’t be paying more than £20. Also don’t pay more than you need for shiny pieces of paper – as long as you get a Companies House incorporation document, Memorandum of Association and Articles of Association in PDF form you have enough to get started.
- Get a business bank account – You MUST use a separate business bank account or your bookkeeping will get into a huge mess very quickly. Most of the big banks offer free business banking for 1 to 2 years. Think about how you expect to be paid. If it’s likely that you will mostly get paid electronically make sure you get a bank account that does electronic transactions cheaply for when you do have to start paying. Sometimes company formation agents will offer you cash back if you setup a bank account at the same time as forming a company, this is worth considering.
- Find an accountant – If you are going down the limited company route you should get an accountant. You should probably go with an online accountant, as they are definitely the future of accounting for freelancers, contractors and small businesses. Yes this will cost you money (we charge £70 + VAT per month) but this is the cost of getting the much larger tax advantages of trading as a limited company. Have a look at our post ‘Does a Freelancer really need an accountant?‘. Your accountant can then help you register for PAYE, Corporation Tax and VAT (if required). A quick note on VAT. You MUST register for VAT if you expect to invoice sales of more than £73,000 a year (at the time of writing). Even if you invoice less than this it’s likely there will be advantages either to reclaim VAT on expenses or to profit from the VAT Flat Rate Scheme.
- Get some good invoicing/bookkeeping software – If your accountant doesn’t provide you with decent bookkeeping software you will have to get your own. This will allow you to raise sales invoices and keep track of your expenses. Just a few companies worth considering are KashFlow, Xero, FreeAgent and Clear Books. All offer free trials and sit futuristically in ‘the cloud’. I’d recommend KashFlow as it’s the simplest to use and has all the functionality you and your accountant will require. We give all our freelancer clients a copy of KashFlow unless they have another preference.
- Find some clients – Now you are ready to pay tax and raise invoices you better find some clients. I can’t help much here but I would definitely recommend PeoplePerHour as a starting point.
The tax you will be required to pay
If you are trading through a limited company you will have to pay tax as follows, please note that all rates are applicable to the 2011/12 tax year and assumes you have no other forms of income during the year:
Class 2 National Insurance – This applies to all self-employed people. You have to pay £2.50 a week. It is possible to opt-out though you may lose your right to state benefits in the future.
Corporation tax on the profits of the company – Your company will incur Corporation Tax of 20% on it’s profits, at least up until you are earning profits of £300,000 or have multiple companies.
Your first £7,475 of earnings – These will be free of income tax and you should pay yourself a salary for this amount through your company. You will be liable for a very small amount of both employers and employees National Insurance but it’s not a deal breaker. The salary will be deductible from the profits of your company.
Between £7,475 and £42,475 – You should pay this money to yourself from your company in the form of a dividend. You will already have paid corporation tax of 20% on the profits and can now pay yourself another £35,000 without incurring additional tax (utilising dividend tax credits)
Above £42,475 – For any additional amounts you will be pushed into the higher rate tax bracket and will have to pay a further 22.5% rate of income tax on your dividends.
Disclaimer – This blog post is very generalised and is no substitute for proper tax advice from a professional who understands your circumstances. Despite all that, I hope it helps.