If there’s two things that are a certainty in life it is that we die and that we pay taxes. In fact, the idea of income tax has been around since 1798 when a prime minister brought in the measure to raise money for the country, originally in the short term. But it was so useful to the government that they kept it going and today, it is a big factor in our lives.
When we own a business, we have to pay taxes on what we earn and are also responsible for reporting this profit to make sure we pay the right amount. So here we look at the basics of income tax and how HMRC works out what we owe.
What you are taxed on
HMRC counts the following as income that you are liable to be taxed on:
- Money earned from a job
- Money earned from a business
- Being self-employed and earning money through a job, including selling services online
- State benefits
- Pensions including state and person pensions
- Rental income
- Benefits from a job
- Income from a trust
However, there are some things that you aren’t required to pay tax on including:
- Interest on savings under the savings allowance
- Income from tax-exempt accounts such as ISAs
- Company shares dividends up to £5,000
- Some state benefits
- Wins on the National Lottery or premium bonds
- Lodger rent if your house is below the rent a room limit
Let’s start with the good news – you don’t pay tax on every penny that you earn. In fact, everyone gets a ‘financial personal allowance’ which is a figure that is revised on an annual basis and is the amount of money a person can earn before they start paying taxes. For the 2016-17 period, this amount is £11,000 so until you reach this figure, you don’t have to pay any tax.
Once you have earned £11,000, you are then what is called a basic rate income tax payer. So, for every £1 that you earn above this threshold, HMRC takes 20p and you retain the other 80p. This rate continues until you reach the current figure of £31,786 at which point you are considered to be on the higher tax rate. This means you will pay 40p in every £1 and retain 60p yourself.
Should you find yourself earning more than £150,000 then you will be in the additional rate for tax group and the amount take will be 45p in every £1. Should you earn over £120,000 a year, you do not get a personal allowance either.
How to pay tax
When you are employed, your tax is paid through the Pay As You Earn or PAYE system. This also collects National Insurance contributions and a code supplied by HMRC tells an employer how much they need to deduct. This code takes into account state benefits if you have to pay tax on them.
When you are self-employed, you need to complete a Self-Assessment tax return. Everyone who earns more than £2,500 needs to complete this and people who earn a high income through their job may also have to complete self-assessment forms.
How much tax?
When you are self-employed, the big question is always how much tax you will have to pay. While the tax rate does give you an idea, there are other things that can offset this amount and reduce or increase the figure.
Whatever the case, the process starts with accurate record keeping. There are no set rules about how you keep records – they can be recorded on paper, digitally or on a software program. They must be accurate and readable and you can be fined if they are not.
Financial records should include any income you have made from your job. But it should also record expenses that you have paid out which can include:
- Travel costs such as parking or bus fares
- Office costs including stationary and telephone bills
- Staff costs for salaries and subcontractors
- Clothing expenses where uniforms or specialists clothing is required
- Items bought to sell, such as raw materials
- Financial costs including insurance and bank charges
- Costs of the business premises including heating, lighting and business rates
- Advertising or marketing including website costs
Another type of cost is known as capital allowances and this is where you buy something to use for your business. Examples include machinery, equipment, and business vehicles such as cars, lorries, or vans.
Some costs need to be broken down into personal and business if the item is used for both – a mobile phone is an example. If your bills are £200 for one year and one third of this was for business while the other two thirds were for personal purposes, then you can only claim for the one third that related to the business.
If a business has no premises, for example if you work from home, then there is an option to claim for a proportion of things such as heating, electricity, mortgage or rent and the use of the telephone or internet. This is worked out on how much of the home is used for business – so if there are eight rooms and the business uses one, it can claim for one eighth of the yearly bills based on you working there full time.
All details of expenses must be kept but only the figures are required to be submitted as part of the self-assessment tax return.
When is the payment due?
The deadline for tax payments is 31st January for tax owed for the previous tax year, known as a balancing payment and the first payment on account. If there is a second payment on account, this will be due on 31st July. You can also use a budget plan to pay at intervals during the year to avoid having a single bill.
If you don’t pay on time, HMRC can take various steps to collect the money, will add interest onto the account and may also add penalties. If you think you cannot pay a bill when it is due, contact them immediately here to discuss options.