There are very few people out there who start to freelance full time and quit their regular jobs. In most cases, people take up freelancing as a side job while doing their daily job. Once they develop a firm footing in freelance work, only then they move it to full time. Consequently, in the initial stages, people freelance on weekends and nights while continuing their day job. There are also cases where people have enough savings to cover their expenses for a while. In such situations, they let go of their regular job and freelance full time. However, we can’t always recommend this as freelance work grows gradually and slowly.
Moreover, doing freelance work as a side job also provides you with the opportunity to test. By test here, we mean to figure out whether you’re made for the freelance world or not. Or whether you are prepared for the specific kind of freelance work you are doing. Who doesn’t like the idea of working for themselves? Everyone does, right? But this can’t always be successful, and it doesn’t work for everyone. Freelancing, as easy as it may sound, can be very daunting and includes a lot of risks. Therefore, having a regular day job alongside freelance work is always a good idea.
However, a few things get complicated when you have two jobs: a regular job and a side job. By things, we mean TAXES. There are several things you need to be aware of if your job setup is similar. For instance, if you are earning money from a regular job as well as a side job, then you must declare all of your income to HMRC, which is vital because all of your income, including the side job income, is eligible for tax and maybe national insurance too. Therefore, HMRC is the first person you go to and tell about your income and job situation because they are the last people you want to annoy. Now, before you involve HMRC into all this, it is essential that you first get things straight. Figure out whether you are officially doing business or is it just some extra cash you are earning on the side. Once you know this, then figure out how to declare this income as rules are different for both.
Is it an official business or non-official casual income on the side?
The UK tax system is diverse and has different rules for almost all business and job settings. Similarly, it has come up with various standards for running a business or only earning some income without making it a company. Moreover, the real-life situations vary from person to person and have no limits to how they can develop. Therefore, HMRC has not put up any hard and fast rules, and the final judgement call lies in your hands. There have been numerous arguments in court over these issues in the last few decades, but there has been no conclusion. So, you have to do with what you have as no specific set of rules apply to everyone.
Let’s delve into the distinction between a business and earning casual income. If the side job or freelance that you are doing is organized and continues for at least a few months with the motive of making a profit, then you are running a business. However, if it is not organized and does not have continuous work for at least a few months, then it is just casual income. To understand it better, if the overall revenue earned from the side job is under £2,000 per annum, then it is not a business rather casual income. There is also the option to run a business through a limited company, but that is quite complicated to set up alongside a regular job. Moreover, if you still can’t figure out whether you are running a side business or not, there is no harm in declaring it as a side business.
Should you declare the income earned from the side job?
Whether you earn your income from a side job or a regular job, if it meets the amount that is taxable in the UK, you are legally obligated to inform HMRC about it. The tax-free personal allowance in the UK is £10,000. So, in any case, if your combined income from the regular day job and the side freelancing job exceeds £10,000, then you must declare it to HMRC. It is as simple as that with no further complications. Don’t wait around for HMRC knocking at your door because they come with consequences. Approach them yourself and at the right time.
If you are already paying an income tax on earnings from the regular job through PAYE, you still must declare your freelance income with HMRC. Because the tax is deducted from the overall income with no exemptions to any kind of income, to understand it better, consider that you earn more than £10,000 through your regular employment and pay tax on it. Moreover, you make around £1000 from your freelance work. Here, you would have to pay tax on the total of both incomes combined so declare it to HMRC as soon as you can.
What to do if it is not a business?
The procedure to declare the income earned from freelance work that is not a business is simple. All you must do is register for a self-assessment for the relevant tax year in which you earned the income. There are two ways to do go about this: 1. Fill out and submit the paper form SA1 2. Go to the HMRC website and fill in the Self-Assessment form. It is important to note that there is a time limit for this which is six months. So, once the tax year has ended in which you earned the income, you have six months before you can declare it to HMRC.
In case you have already registered yourself for the Self-Assessment form, then HMRC does not require you to register for it again for the side income. HMRC will duly notify you shortly after the end of the tax year in which the freelance income was earned as well as the other regular income. All you must do is add the freelance income in the “other income” section on the Self-Assessment form. If you are not doing it online and filing a return on paper, then the boxes numbered 16 and 17 on page TR3 are to be filled. Moreover, you also must fill in the details of the job that you have been doing on the side as HMRC needs to make sure that they apply the right tax rules on you. Your income earned through freelance work will be taxed like how your regular income is taxed. Moreover, no national insurance must be paid on income earned by freelance work which is not a business.
When is the right time to register with HMRC?
People are always worried about whether they should tell their employer about their side job or not. However, this should be the least of their worries as that situation can be handled, but the more important thing is telling the tax collector, HMRC. HMRC has recommended everyone to register with them and declare their incomes as soon as a new business venture starts operating. If you are a self-employed sole trader, then HMRC legally requires you to register with them if the annual income exceeds £1,000 in a tax year.
Now, with your regular job going on, you already have full-time employment. In such a case, you have to wait until you earn your first £1,000 from your freelance work as a second job. Here again, you would have to inform HMRC by fulfilling a self-assessment form to file your tax returns. If you fail to do so, there will be consequences in terms of fines imposed by HMRC. On the contrary, if you feel like you won’t be making more than a £1,000 in a tax year, there is no requirement to file for a self-assessment form as HMRC has recently introduced the £1,000 trading allowance in order to make things easier for people having two jobs: one regular and one side job.
What are the chances that your employer will find out?
Your employer finding out that you have a side job shouldn’t be a problem. However, it is only reasonable for you to be worried about them finding out as things might change after that. Additionally, you should be extremely careful with such things as your employer may have conditioned you to not take upon any other form of work as long as you are in contract with them.
You employer won’t find out unless someone sells you out or you decide to tell them yourself. Your tax returns and all the data are a secret between you and HMRC as it is entirely confidential. However, this is only true if you register with HMRC as a sole trader. Rules for limited companies differ as the details about them are made available to the public at the Companies House. Consequently, the chances of your employer finding out about your side job increase. It is not always a good idea to play hide and seek games with such things, and so we don’t recommend it. However, it is not impossible, and you can smoothly go through with it if you are extra careful.
Here is how you can work out your taxable income working as a freelancer on the side!
We cannot work the taxable income in detail here as there are space constraints. However, there are certain expenses that you can claim before you come up with the final amount of income to be taxed. For instance, all of your costs that are incurred by your business venture as well as for your private use, the business expense portion can be claimed. For example, the telephone bills, vehicle costs etc. this varies from person to person and their method, which is divided into two: private use and business use. Moreover, you also have the option to claim a portion of your household expenses that are used for running down your freelance work. Which, again, is determined by the space and rooms you and for what quantity of time.
Moreover, you can also claim the equipment expenses incurred for the business. Any equipment bought for the company and used for over a year for business purposes does not fall under business expense. In this case, you are eligible for tax relief in the name of capital allowance. It is the same amount of tax relief for most of the items. However, it now falls under the category of Annual Investment Allowances. If the thing is a vehicle, the situation gets more complicated.
People usually make two widespread mistakes when working their taxable income. These are the following:
- If you invest all the income earned back in stocks, you have made no profit, and so you are not eligible for any tax. It is important to note here that purchasing of shares is a payment and not an expense. The only situation where a stock is considered a fee is when you have sold it. So, keep in mind that tax is paid on profits and not payments.
- That if you follow all the money that you have earned in a business account and don’t pay yourself any wages or draw the cash out, you won’t be liable to pay tax on that income. Which is entirely wrong as when you are self-employed, HMRC does not differentiate between your private money and business money. Therefore, whether you pay yourself a wage or not, in either case, you must pay tax on that money as HMRC won’t let it go.
Moreover, since the end of the tax year in 2014, April 5, HMRC has allowed small businesses to provide tax figures based on cash, which makes it simple as it does not require you to work out your payments by adjusting for stock in hand and other required adjustments. All you have to do is use your receipts and payments to work out your income.
HMRC gives you the option to choose this method on your own will. However, as simple as this method is, it does come with certain drawbacks. If you pick this method, you won’t have the liberty to balance any losses against any other income earned. Moreover, there is a limit to the amount of claimable interest with this method. Additionally, it means that you will be paying a lower amount of tax with this method if your stocks are increasing. However, if your shares are decreasing, then you will be paying more tax. Good news is that throughout the life of your business, it won’t make a difference as the more and less tax balance themselves out over time.
Let’s play with some numbers to make you understand better!
When you are working out your tax, the usual way to go is that you pay taxes on your income earned through regular job via PAYE. For the income earned by freelance work, it depends on the amount of profit you have turned. Remember it is the amount of PROFIT, not TURNOVER, which you are supposed to fill in the tax return.
The tax-free personal allowance will be allocated to your income earned through regular employment, which means that any income made through freelance work will be charged at the highest rate of tax. For example, if your income is less than £41,865, you will be charged a 20% tax on it. If it is higher than £41,865, then you would have to pay 40% tax on it. If you are earning a good £150,000, the tax rate can go as high as 45%.
Moreover, you also must pay class 4 national insurance on any income earned through freelance work. The rate for this is 9% on revenue ranging from £7,956 to £41,865 in a tax year. It falls to 2% if the income is above £41,865. Moreover, if you have a combined income exceeding £40,000 in one tax year, then HMRC restricts the Class 4 National Insurance payable.
It is useful to know what percentage of self-employed earnings should be set aside for tax, but as seen, this is not possible. The amount could vary from 20% to 59% (possible, but rare). For someone with average earnings, we recommend setting aside around 25%, and then completing the tax return shortly after April 5 each year so that you get several months’ notice of what the final liability will be.
Important dates for TAX!
The date to pay the tax and Class 4 National Insurance on your total income earned through freelance work after being adjusted for tax is January 31 after the tax year has ended. For example, if you started your freelance work somewhere in November 2015, it will fall in the tax year that goes till April 5, 2016. Once this end, you will have time till January 31, 2017, to pay your taxes and National Insurance.
Moreover, if the total you pay for tax and national insurance exceeds £1,000 in the tax year and amounts to more than 20% of your total tax paid in that year, HMRC will require to pay the amount in advance every six months.
There is another way you can pay tax for your income earned through freelance work, but it is a bit risky. If you have filed your tax returns online by December 30 and your total liability for January 31 is below £3,000, you will have the option to pay your tax via PAYE. This way, it will be deducted from your salary directly. Here comes the risk. If it is deducted from your salary, your employer can notice it and find out about your freelance work or side job/business. If you do not wish to risk this, you can tick the box two on page number five of the tax return before you file it. As soon as you submit it, HMRC will start working on sending you statements via post, filling you in on how to pay the tax and what amount is to be paid.
What about National Insurance?
If you start working as a freelancer on the side while keeping your regular job, it won’t impact the national insurance you pay on your monthly income. However, it will be different from your income earned by freelance profits. If you are making profits that exceed £6,365 through your freelance work, then you would be charged a flat £3.00 weekly. HMRC calls this Class 2 national insurance.
Class 1 national insurance is paid through PAYE via the employer you are working under, so there is a risk of them finding out. However, class 2 national insurance is paid to HMRC directly via direct debit, which can be registered for online at Gov.uk.
There is also the option of Class 4 National Insurance for all those who are earning good money through freelance work. As discussed, before it is charged at 9% for profits ranging from £8,632 to £50,000. For any benefits exceeding the £50,000 mark, a 2% charge rate is applied. Class 4 National Insurance contributions are filed in the same Self-Assessment tax return form as the income tax. To understand it better, let’s look at the table below with the same figure we used for our examples:
|Profits from self-employment||£20,000|
|Class 2 National Insurance (52 weeks @ £3.00 per week)||£156.00|
|Class 4 National Insurance (9% on profit between £8,632 and £50,000 – in this example the benefit is only £20,000 so 9% * £11,368)||£1,023.12|
|Total National Insurance paid||£1,179.12|
Don’t forget that, along with your freelance insurance, you also must pay your Class 1 National Insurance on income earned through your regular employment.
The Bottom Line
Many people aspire to work as a freelancer as the world is increasingly leaning towards it. You can also do it, but it is always better to be well informed about the stuff that you are getting yourself into. Therefore, it is vital that you learn everything tax-related about working as a freelancer on the side alongside your regular job to avoid any inconveniences at the hands of HMRC because let’s be honest, nobody wants that.
Shoaib Aslam is the co-founder of Pearl Chartered Accountants, a UK-based chartered accountancy firm that has multiple locations across London. They are experts in helping startups and established businesses with all aspects of growth, strategy, scaling up, accounting and tax planning.