Contrary to popular belief, the terms ‘employed’ and ‘self-employed’ are not so opposites. In the world of HMRC, being employed and self-employed at the same time is possible. It’s actually pretty common. But what implications does working on the side have for your freelance tax liability?
A sole trader freelancer? How much income tax will you pay?
All the examples are based on the HMRC published rates and thresholds for the 2019/20 tax year.
Income tax is always calculated on total earnings, so you’ll have to pay tax on amounts above the personal allowance for your combined income from employment and sole trader profits.
It’s important to realise that if your sole trader profits push your total earnings into a higher tax band, you’ll have to pay the higher rate.
An example for the 2019/20* tax year:
Income from an employer £35,000
Profits from sole trade (self-employment) £20,000
Total income £55,000
Personal allowance (£12,500)
Total taxable income £42,500
Income Tax paid at basic rate (20%)* £7,500
Income Tax paid at higher rate (40%)* £2,000
Total Income Tax paid £9,500
You’ll pay income tax of 20% on all earnings above your personal allowance and below the upper limit of the basic rate, which is £37,500 for the 2019/20 tax year. You’ll pay income tax of 40% on all earnings above the basic rate limit until you reach the higher rate limit (which in the 2019/20 tax year is £100,000). In this example, you pay 40% tax on income of £5,000.
When you prepare your annual Self-Assessment tax return, you will disclose the tax already paid on your earnings from your employer (in this example £35,000 would have been taxed under PAYE arrangements). So HMRC will know you have already paid tax on part of your total income. The amount of tax you pay on your profits from self-employment (£20,000 in this example) will be worked out by HMRC when you submit your Self-Assessment.
Sole trader or limited company?
As a self-employed person, you can choose to work as a sole trader, or form your own limited company.
The difference is that if you’re a sole trader then there’s no legal separation between you and your business. You’re personally responsible for all activities of your business, including debts.
If you form a limited company you create a separate legal entity and you have no personal liability. But, you’ll have specific legal and statutory responsibilities to fulfil as a director of the company. This also has a number of tax implications.
What about expenses?
One of the main benefits of registering as self-employed as a sole trader is that you get to offset your business expenses against your income. You’re only taxed on your self-employed profits.
When should I tell HMRC?
Although your employer doesn’t need to know, but you need to inform the taxman! HMRC recommend that you let them know as soon as you start your new business.
It’s a legal requirement to register with HMRC as a new business as soon as your combined earnings exceed your personal allowance.
If you’re already employed full-time, this is likely to happen as soon as you receive your first self-employed income. Once this happens, you’ll have until 5th October after the end of the tax year to register for Self-Assessment and let HMRC know, or risk paying a fine.
Will my employer find out?
It usually won’t be a problem, it’s understandable that you might not want your employer to know that you’re working on other projects. Be careful, though, because your employment contract might forbid you to take on outside work, especially if there is a risk of competition with your current employer.
Your tax affairs are entirely confidential and HMRC will not inform your employer if you also register as self-employed. Be aware that if you form a limited company your details are publicly available at Companies House, so your employer could find out about your business that way.
Of course, we’d never recommend that you mislead your employer. However, it’s possible to start outside work without disclosing it. Just be aware that you do so at your own risk.