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Self-Employed
Are you an aspiring entrepreneur?
Are you an aspiring entrepreneur eager to build your own business? There are several factors to consider before embarking on self-employment. One of the most important first decisions is choosing the right business structure. You can work as a self-employed individual (sole trader) or operate through a limited company. Alternatively, if there are two or more of you in business together, a partnership may be a good option.
Business structure
Self-employed – sole trader
When working as a self-employed person or sole trader, you’re running your own business as an individual.
Register with HMRC
You will need to register with HMRC as self-employed once your income exceeds £1,000 in a tax year. You will pay tax and national insurance on your net profits via an annual self assessment tax return. You need to submit your annual tax return and pay any tax owed to HMRC by January 31st of the following tax year. For instance, if you are trading during the 2025/26 tax year (6th April 2025 to 5th April 2026), your tax return and payment must be received by HMRC by 31st January 2027.
Tax and national insurance
- Your net income (income less expenses) is taxed as PAYE, after deducting your personal allowance. You will pay tax of 20% on income up to £50,270.
- Class 4 national insurance contributions of 6% are due on net income between £12,570 and £50,270. Income over £50,270 incurs NI of 2%.
- Self-employed individuals with income below £6,275 can make voluntary class 2 contributions of £3.45 per week to maintain their right to certain state benefits.
Financial responsibilities
As a self-employed person, you’ll need to:
- Keep detailed records of all business income and expenses
- Calculate your taxable profit and pay tax and NI contributions
It is important to note that unlike a limited company, you do not have limited liability as a self-employed person. There is no legal separation between you and your business and you are personally liable for any debts of your business. As such, your personal assets could be at risk if your business faces financial difficulties.
Limited Company
A limited company exists as a separate legal entity from its owners. As a shareholder and director, your personal assets are protected since the company itself – not you – is responsible for any business debts. The company is “limited by shares,” meaning your financial liability is limited to your investment in the company.
Register with Companies House and HMRC
A limited company must register with Companies House for its formation and annual reporting. It must also register with HMRC for corporation tax. Limited companies have the following annual filing and reporting obligations:
- File an annual return with Companies House
- File annual financial accounts with Companies House
- Submit an annual corporation tax return with HMRC and pay any tax due on their net profit.
- Both the financial accounts and corporation tax return must be filed within 9 months of the end of the company’s financial year.
Tax and profit distribution
Limited companies pay corporation tax of between 19% and 25% depending on their net profit. Companies with net profits under £50,000 pay 19% corporation tax.
After paying corporation tax, the remaining profits can be distributed to the shareholder/s of the company as dividends. Some of the profit can also be retained within the company as reserves.
As a director/shareholder of a limited you can reimburse yourself by:
- Paying yourself a salary from the company and paying PAYE and NI. This is a deductible expense which reduces the corporation tax liability.
- Draw dividends from the after tax profits. Dividends are taxed at lower rates than PAYE, with basic rate taxpayers paying 8.75% tax on dividends.
- To maximise tax efficiency, use a combination of salary and dividend payments.
It is advisable to use an accountant to prepare your financial accounts and corporation tax return. They will make sure you are compliant with Companies House and HMRC requirements and advise on tax efficient strategies for your business.
Partnerships
Traditional partnerships
A traditional partnership may be appropriate if there are two or more of you running a business. Partnerships must be registered with HMRC and each partner:
- Share responsibility for the business, and joint liability for all bills and any losses.
- Partners receive a share of the profits and pay income tax on their profits via a self assessment, paying PAYE and NI.
- A nominated partner is responsible for submitting the partnership’s tax return and maintaining the business records.
Limited partnerships
This is an alternative structure which offers limited liability. Limited partnerships must be registered with Companies House. They must have one general partner and at least one limited partner. All partners pay income tax on their share of the profits through self assessment tax returns. More details about partnerships are available on the gov.uk website.
Set up a business partnership: Setting up – GOV.UK (www.gov.uk)
To learn more about tax for self-employed people and limited companies, click on the link:
VAT – value added tax
Whichever business structure you choose you may need to register for VAT with HMRC. You need to register for VAT if your turnover exceeds £90,000 in the last 12 months or if you expect it to exceed £90,000 in the next 30 days. VAT registered businesses charge output tax on the goods and services they sell. Input tax is the VAT you pay on goods and services you purchase for running your business. On the VAT return, you reclaim the input tax and offset this against the output tax owing to HMRC. VAT returns are usually submitted to HMRC every 3 months.
To illustrate how VAT works, if you buy materials to make your product costing £100 plus VAT of £20, you pay a total of £120. You make your product and sell it for £150 plus VAT of £30, selling the item for £180. On the VAT return, the input tax is £20 and the output tax is £30. You will deduct the input tax of £20 from the output tax of £30 and pay the balance of £10 to HMRC.
VAT returns are submitted digitally to HMRC under MTD or making tax digital, which requires an accounting software package.
Some business terms
Turnover or Sales is the total sales value (selling price) of the goods or services you have sold.
Cost of Sales is the cost of producing the goods and includes the cost of the raw materials and other costs that are directly attributable to the production of the goods.
Gross Profit is turnover or sales less the cost of sales.
Operating Expenses are the general running costs of the business, such as salaries, rent, stationery, electricity, water, etc.
Net Profit is gross profit minus operating costs or sales minus cost of sales minus operating expenses.
Fixed Costs are costs that do not change with an increase or decrease in the number of goods produced. Fixed costs are longer term costs that a company is committed to paying, such as rent.
Variable Costs are costs that increase or decrease with changes in production levels, such as raw material costs.
Financial Statements: The two main financial statements are the Balance Sheet and the Profit and Loss Statement. The Balance Sheet is a statement of the assets, liabilities, and equity of the company at a point in time. The equity of a company is the assets of the company less the liabilities. A Profit and Loss report details the income and expenditure for a specific period.
Other aspects of running a business
Sales, marketing & supply chain
- Sales – determine your target market and product offering
- Marketing – digital marketing and traditional marketing
- Supply chain – how you procure raw materials for your products and distribute finished goods
- Managing a website
- E-commerce
Administration & finance
- Business insurance, commercial, and professional indemnity insurance for contractors
- Payroll, pension contributions, employment contracts, and other HR (Human resources)
- GDPR – General Data Protection Regulation – rules on how you gather, use, store, and manage personal data
- Health and safety in the workplace
- Accounting and finance
- Information technology and security
Other resources
If you would like to learn more about running a business or working for yourself, take a look at our sister website, Tyro Business: