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Understanding Self Employment Tax

Self-employed income tax

Self-employed people pay income tax on their profits, rather than their gross income. To work out the correct figure, you need to deduct business expenses from your business income.

You can also claim capital allowances and deduct any losses carried over from previous years. The resulting amount is your taxable income.

Self-employed tax return

To work out whether you must pay income tax, you need to fill in the self-employment supplement (SA103) as well as the main tax return.

Usually this is sent to you automatically once you've registered as self-employed.

If you have registered but don’t receive one, you can download it from our useful forms section or get a copy by calling the HMRC orderline (0845 900 0404).

Tax return supplements

There are now two tax return supplements – a short one and a full one.

You can fill in the short one if your turnover for 2013/14 was £77,000 (£73,000 in 2012/13) or less and no complications, such as a change of accounting date, apply.

However, you cannot use the short one if your accounting period is not the same as your basis period (i.e. your business year), so you may not be able to use it in the first year. It's up to you to make sure you get the right supplement.

Partnerships and limited companies

The supplement and the advice in this section apply to people who are sole traders. If you are in partnership, you need the partnership supplement.

If you run your own limited company, you are an employee of the business and need the employment supplement.

Self-employed National Insurance

If you're self-employed, it's just income tax you need to pay on your profits. You also have to make National Insurance contributions.

Building up National Insurance contribution entitles you to the State Pension, and other benefits, but it can be complicated to calculate.

This guide gives you a step-by-step guide to working out how much National Insurance you need to pay if you're self-employed, and other taxes you might need to pay.

Self-employed National Insurance

If you're self-employed, there are two types of National Insurance contribution you may have to pay. These will differ based on how much profit you make in a year.

Class 2 National Insurance contributions

• If you make profits over £5,885 in 2014/15, you have to pay Class 2 contributions

• The amount you have to pay is £2.75 a week in 2014/15 tax year (£2.70 in 2013/14)

• You can claim exemption if your annual profits are below £5,885 in 2014/15 (£5,725 in 2013/14).

Class 4 National Insurance contributions

• If you make profits above £7,956 in 2014/15 (£7,755 in 2013/14), you have to pay Class 4 contributions

• The amount you have to pay is 9% on profits between £7,956 and £41,865 in the 2014/15 and 2013/14 tax year

• On profits above £41,865, the rate falls to 2%.

Self-employed value added tax (VAT)

If you're self-employed you will have to pay or reclaim VAT quarterly if your turnover is over £79,000 in 2013/14.

Up to this you can register voluntarily, which may be worthwhile if you can claim a lot of VAT on things bought for your business.

Not registered for VAT

If you aren't registered for tax you cannot reclaim VAT on things you buy for your business, but you should use prices including VAT when you are recording expenses and allowances so you earn tax relief on the VAT.

Registered for VAT

If you are registered for VAT you must charge it on all goods and services you supply which incur VAT. There are a few exceptions, such as free services and one-off free gifts worth less than £50.

Flat rate VAT scheme

If your turnover is less than £150,000 it could be worth considering the flat-rate scheme. The scheme simplifies your VAT accounting by calculating your VAT payments as a percentage of your VAT-inclusive turnover. It can be good value for small businesses and reduces admin.

Self-employed capital gains tax (CGT)

If you sell your business, or if you sell your home and part of it has been used exclusively for business, you may have to pay capital gains tax on it. HMRC makes a distinction between using a home 'solely' for business and 'exclusively' for business.

If your home is used 'solely' for business it means that part of your home is used purely for business, but only part of the time. 'Exclusively' means part of your home is set aside for business at all times.

CGT becomes due when you sell your home only when part has been used 'exclusively' for business, not 'solely'.

For CGT rates please refer to our tax rates guide