The amount of income a self-employed person in the UK can earn before having to pay tax depends on their personal tax allowance. For the 2022/23 tax year, the standard personal allowance is £12,570. This means self-employed individuals can earn up to £12,570 in profits each year without having to pay any income tax.
However, the personal allowance starts to be reduced once total income exceeds £100,000. For every £2 earned above £100,000, the personal allowance reduces by £1. This means once total income reaches £125,140 or more, the personal allowance is reduced to zero.
There are also two other factors that can impact how much a self-employed person can earn tax-free:
1. Registration for self-assessment
2. Class 2 National Insurance contributions
Let’s take a detailed look at how these factors affect the tax-free allowance for the self-employed.
Do you need to register for self-assessment?
Self-employed individuals whose annual profits are £1,000 or more must register for self-assessment and file a tax return each year. This requirement exists even if the level of profits falls under the personal allowance threshold.
Therefore, any self-employed person earning £1,000 or more in profits each year must complete a self-assessment tax return. They may not end up owing any income tax if their profits are covered by the personal allowance. But they still need to go through the self-assessment filing process.
Class 2 National Insurance contributions
Class 2 National Insurance contributions (NICs) are a form of social security tax that self-employed individuals must pay if their annual profits are £6,725 or more.
The rate for Class 2 NICs in 2022/23 is £3.15 per week. So this equates to £163.80 due for the full tax year.
Self-employed individuals earning between £6,725 and £12,570 in profits would therefore not pay any income tax but would still be liable for Class 2 NICs.
It’s also important to note that Class 2 NICs cannot be deducted as a business expense. So paying Class 2 NICs effectively reduces net profit.
What is the self-employed tax-free allowance?
Taking into account the above factors, we can summarise the tax-free profit allowances for self-employed individuals in 2022/23 as:
Annual profits | Income tax due | Class 2 NICs due |
Up to £6,724 | £0 | £0 |
£6,725 to £12,570 | £0 | £163.80 |
Over £12,570 | Tax due on profits over £12,570 | £163.80 |
Therefore, the maximum tax-free profit allowance before income tax applies is £12,570. However, Class 2 NICs start to apply on profits over £6,724.
Example scenarios
To illustrate how these rules work in practice, let’s look at a few example scenarios for self-employed individuals in 2022/23:
Example 1
Sally has annual profits of £5,000
– Her profits fall under £6,724 so she pays no income tax or Class 2 NICs. Her tax-free allowance is £5,000
Example 2
Lee has annual profits of £8,000
– His profits exceed £6,724 so he must pay Class 2 NICs of £163.80
– His profits fall under £12,570 so he pays no income tax
– His tax-free allowance is £7,836.20 (£8,000 profits minus £163.80 Class 2 NICs)
Example 3
Tina has annual profits of £15,000
– Her profits exceed £12,570 so she must pay income tax on £2,430 of her profits (£15,000 minus £12,570)
– She must also pay £163.80 in Class 2 NICs
– Her tax-free allowance is therefore £12,406.20 (£15,000 minus £2,430 income tax minus £163.80 Class 2 NICs)
Other factors that can affect the tax-free allowance
There are a few other things that can impact on the tax-free profit allowance for self-employed people:
– *Previous years’ losses*: If a self-employed person made a loss in a prior tax year, they may be able to offset this against profits in the current year. This reduces taxable profit.
– *Pension contributions*: Paying into a personal pension can reduce taxable profit subject to annual and lifetime allowances.
– *Capital allowances*: Allowances that provide tax relief on certain capital assets purchased for the business. These lower taxable profit.
– *Carry back on losses*: Losses can sometimes be carried back to earlier tax years to receive a tax refund.
– *Business expenses*: Allowable expenses that are wholly and exclusively for the business reduce taxable profit.
– *Trading allowance*: An allowance of £1,000 that self-employed people can deduct from revenues before calculating taxable profit.
– *Rent a room relief*: An allowance that lets individuals earning rental income on residential property deduct up to £7,500 before calculating taxable profit.
So in many cases, the amount of tax-free profit a self-employed person can receive may be higher than £12,570 once these factors are taken into account.
When do you start paying tax as a self-employed person?
The main milestones for a self-employed person around when tax liabilities start are:
– *Over £1,000 in profits*: Must register for self-assessment and file a tax return
– *Over £6,724 in profits*: Become liable to pay Class 2 NICs
– *Over £12,570 in profits*: Income tax begins to apply on profit over the personal allowance
– *Over £50,270 in profits*: Must register for VAT (unless turnover is less than £85,000)
So most self-employed people become liable to pay some form of tax once their profits exceed £6,724 in a tax year.
How do you calculate taxable profit each year?
To determine their taxable profit each year, a self-employed person needs to:
1. Calculate total business revenue/turnover
2. Deduct allowable business expenses
Allowable expenses include things like:
– Cost of goods sold
– Salaries and wages
– Rent
– Vehicle costs
– Insurance
– Accounting fees
– Advertising and promotion
– Interest on business loans
– Repairs and maintenance
– Utilities
3. Deduct capital allowances
4. Deduct any other tax reliefs (e.g. pension contributions)
5. The remaining figure after deducting 1 to 4 is taxable profit
Keeping accurate records of all business income and expenses is crucial to calculating the correct taxable profit each year.
What tax rates apply to self-employed profits?
Self-employed profits are taxed at the same rates as income from employment or pensions. The main rates for 2022/23 are:
Band of taxable income | Tax rate |
Personal Allowance | 0% |
£12,571 to £50,270 | 20% (basic rate) |
£50,271 to £150,000 | 40% (higher rate) |
Over £150,000 | 45% (additional rate) |
In addition, profits between £9,880 and £50,270 are charged Class 4 NICs at 9%. Profits over £50,270 are charged Class 4 NICs at 2%.
So the self-employed may need to pay income tax, Class 2 NICs and Class 4 NICs on their profits.
When do you need to report and pay tax on self-employed income?
Reporting obligations for self-employed taxes include:
– *Registering for self-assessment*: Must be done by 5th October following the end of the tax year if profits exceed £1,000
– *Submitting a tax return*: Tax returns are due by 31st January following the end of the tax year
– *Paying Class 2 NICs*: Due in quarterly instalments (can be deferred until 31st January in first year)
– *Paying Class 4 NICs*: Due together with income tax by 31st January following the tax year
– *Making income tax payments on account*: Usually split into two payments on 31st January and 31st July to cover the following year’s liability
So for the 2022/23 tax year, key deadlines would be:
– Register for self-assessment by 5th October 2023
– File 2022/23 tax return and pay Class 4 NICs/income tax by 31st January 2024
– Make first 2023/24 payment on account by 31st January 2024
Keeping on top of self-employment tax obligations is crucial to avoid penalties.
Conclusion
The key points on how much a self-employed person can earn before paying tax are:
– The personal allowance provides tax-free profits up to £12,570
– But Class 2 NICs start to apply once profits exceed £6,724
– Other factors like business expenses can increase the tax-free allowance
– Most self-employed people pay some tax once profits exceed £6,724
– Keeping accurate records is important to calculate taxable profit correctly
– Tax returns and payments have strict deadlines to avoid penalties
With good planning and record keeping, self-employed individuals can make the most of their tax-free allowances. But they need to factor in tax and NICs costs once profits exceed certain thresholds.