It’s tax time. Are you ready? If you are unsure about whether you need to be ready, read on. We are going to debunk the mystery that is Self-Assessment & Income Tax.
What is Income Tax?
Income tax is a tax you pay on your income, aka the money you earn from work or other ventures. Here are some of the things you have to pay tax:
money you earn from employment
profits you make if you’re self-employed - including from services you sell through websites or apps
some state benefits
some grants, including the Self-Employment Income Support Scheme, the Small Business Grant Fund, the Retail, Hospitality and Leisure Grant Fund, the Coronavirus Job Retention Scheme and the Test and Trace Support Payment in England (or the Self-isolation Support Payment in Scotland and the Self-isolation Support Scheme in Wales)
most pensions, including state pensions, company and personal pensions and retirement annuities
rental income (unless you’re a live-in landlord and get less than the rent a room limit)
benefits you get from your job
income from a trust
interest on savings over your savings allowance
But there are also things you don't have to pay tax on such as:
the first £1,000 of income from self-employment - this is your ‘trading allowance’
the first £1,000 of income from property you rent (unless you’re using the Rent a Room Scheme)
income from tax-exempt accounts, like Individual Savings Accounts (ISAs) and National Savings Certificates
dividends from company shares under your dividends allowance
some state benefits
premium bond or National Lottery wins
rent you get from a lodger in your house that’s below the rent a room limit
Do I pay tax on every penny I earn?
The short answer is no. You can claim tax reliefs on a lot of the things you buy for your business if you're trading and recording income as such. This helps reduce the amount of tax you get charged. These are commonly referred to as "allowable expenses".
As well, most people in the UK get something called a personal allowance, which is essentially an amount of money they can earn tax free.
The personal allowance may vary depending on your tax code, but for most people the amount they can earn before paying tax is £12,570 a year. (2021/2022 figures)
This is on TOTAL income. So if you are employed full time AND run your own business, then you don't get £12,570 per business of tax free money. It's across all businesses.
What are the income tax rates?
Great question. Let's say you have a standard personal allowance of £12,570. Here's how you would be taxed according to your earnings in England and Wales:
If you live in Scotland, here is how your tax bands look:
So now you what Income Tax is, what you pay it on and how much you pay. There is a whole host of other information about National Insurance contributions, why we pay them, what we pay and how, but that is for a separate article coming to you this week.
Knowing what you do about Income Tax, you're in a great place to start your Self-assessment...
What is a Self-Assessment?
It is a way of telling HMRC (Her Majesty’s Revenue & Customs) how much money you have brought in. Why? So you can pay tax on it. The tax you’d pay would be National Insurance as well as Income Tax.
When you’re employed by a company, the tax you owe to HMRC is usually taken off your wages by your employer. But working for yourself as a sole trader as an example, you become responsible for letting HMRC know about your income so you can then pay tax.
Do I need to file a self-assessment?
You may need to file a self-assessment this year if you meet one of these descriptions:
You are self-employed having registered your business before April 6th 2020
You are a company director
You earn more than £100,000 a year
Have savings or investments of more than £10,000 a year before tax.
Receive income from abroad
Earned £1000 in untaxed income eg from renting property or selling things on ebay. (If you have both types of income, you’ll get a £1,000 allowance for each.)
If you are unsure about whether you need to file a self-assessment, then HMRC have a really handy test you can take to see if you should file. https://www.gov.uk/check-if-you-need-tax-return.
Beware though, if this tool says you don’t need to file but you receive a letter from HMRC saying you do, then you do.
How do I file?
There are two ways:
Via a paper form
Via their online service.
When you have to send your return back to HMRC depends on which method you choose to complete it.
So tell me more about the deadlines…
Ok let’s start with registering for self-assessment: you must have registered for Self Assessment by the 5th October in the tax year you are expected to file a self-assessment. For instance, if you started your business on the 9th May 2020, you won’t need to register for Self-Assessment until the very latest 5th October 2021.
Registering for Self-Assessment: 5th Ocotber
Filing a paper return: 31st October
Filing an online return: 31st January
Paying your tax bill: 31st January
This last deadline is why it is NOT ok to file your return last minute unless you have anticipated how much your tax bill will come to.
Right, so, I have taken the test, I know what method to use, I know the deadlines; now what?
Now you save. I know you dread it, but it is ABSOLUTELY NECESSARY.
This is your first year of business, right? So you won’t be expected to file an online return this coming January. But you will next January. And your year 1 tax bill is likely to be double what you expected…
SAY WHAT NOW?!
Let’s talk about Payments on Account.
What the heck is Payment on Account?
A payment on account is an advance payment toward your next tax bill.
The reason year 1 is so hard is because you have to pay the tax bill for the year you’d been trading in full by the 31st January the following year AND 50% toward next years tax bill at the same time. This is then followed by another 50% payment on the 31st July.
The advance payment HMRC asks for is based on your earnings you submitted in that first self-assessment tax return. It’s good to note, you still get your personal allowances as well. Click here to see more about those.
But I still don’t get it…*sobs in the corner*
I know it’s hard to digest and may even be hard to wrap your head around. So here is a working example:
Let’s say I need to fill out my self-assessment this year. I have made £25,000 this tax year and I fill in my self-assessment reflecting that.
I know I will only pay income tax on £12,570 of that. And I know with Income tax and National Insurance that will be around 25% of that figure I’ll have to pay to the tax man. So that is what I need to save. So, I know I’ll be looking at owing £3142.50 to HMRC for the 20/21 tax year which is liveable. And I need that paid by Jan 31st 2022.
But HMRC say, “Jess, we think based on this year’s tax bill, that you will have to pay roughly the same amount of tax next year, so we’d like a second payment of £3142.50 to cover next year’s tax payment please. Oh, but you only have to pay half of the second payment by Jan 31st 2022, the other half you can pay July 31st 2022”.
Essentially in my first year of paying tax, I will have to pay the tax man double what I expected working out at £6285. *Face palm*
Does that mean I’ll be expected to pay double what I owe every year?
NO. This happens usually in your first year of main trading.
Essentially from here on out, you pay your tax bill for the following year only. One bill paid across January and July. So you can start saving 25% of your profits again, rather than the 50% you'll essentially need to save in year 1.
What if I start making more money in my business, will my Payment on Account Increase?
Yes. And you’ll be expected to pay a Balancing Payment.
This is why you are still required to fill out a self-assessment every year; so you can let HMRC know if you’ve made more or less. And if you make more, they want payment they have missed out on.
Here’s another working example:
If then next tax year I make £32,500 and £20,000 of that is taxable, when I do my self-assessment, I know that my tax bill is going to be £5000. I paid £3142.50 last year toward it so I’ll have to make a balancing payment of £1857.50 AND an increased payment on account from last year (because my earnings have increased) to £5000.
So the £1857.50 and the first half of the payment on account (£2500) will be due 31st Jan 2023 and the second half of the payment on account (£2500) will be due 31st July 2023.
It’s complicated. Long winded. Ridiculous. But necessary.
What happens if I don’t file or pay when I’m supposed to?
If you miss the deadline for submitting your self-assessment or paying your tax bill up to 3 months late, you will be charged a penalty of £100.
You’ll have to pay more penalties if it’s later or if you pay your tax bill late. You’ll also be charged interest on late payments.
So I would 100% recommend always filing on time and making sure you save to be able to pay on time.
Oh man, this is so much information. I need help.
You’ve come to the right place.
If you want a DIY kit to help you through Self-Assessment, check out our Self-Assessment Survival Kit.
If you want more personal help, book in for one of our 1:1 Power Hour's. These sessions are 60 minutes and are an opportunity for you to pick our brains, getting real understanding on all things tax. On top, after the call you receive a copy of our clever tax tracker, our “Good to Know” PDF guide plus our “Guide to Allowable Expenses”.
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