A recent study by UHY, the international accountancy network, found that the last year saw a rise of 14% in the number of new businesses started in the UK. In real terms 726,000 new businesses were created in 2020 compared to 636,000 in 2019. This outpaces the global trend of just a 6% increase in start-ups.
The one thing that all these new businesses do have in common is that they need to do their accounts, file tax returns but more importantly extract money from their business to live on.
Ditch the monthly payslip
Moving into the world of self employment means ditching the usual monthly PAYE (pay as you earn system of taxation) payslip showing how much you’ve earned after deductions with the net amount popping into your bank account on a regular basis.
Operate your own Pay as You Earn Tax scheme
Alongside all of the tasks associated with running your business, from day one you’ll take responsibility for your tax bill and work out how much you can take out from your business to pay yourself – in short you’ll need to generate your own self employed payslip.
In reality this means that you have to be disciplined enough to operate your own self employment pay as you earn scheme.
You’ll need to put aside enough money to make the tax payments when they are due which will be a long time after you’ve earned the income. So you’ll have to resist the temptation of dipping into your tax savings when times get tough – it’s not your money!
However this doesn’t have to be as daunting as it sounds if you implement some very simple tasks to keep on top of your business, tax and your self employed payslip.
How much is yours and how much belongs to HMRC?
The first thing to do is to set a recurring task (weekly or monthly depending on your needs) to work out how much money in the business is yours and how much belongs to HMRC.
Put this recurring task into your diary system.
To work out your business money follow a basic rule of thumb being:
Income
Less
Business Costs
=
Profit
Less
Tax
=
Money you can take out of the business
Where can you find these figures?
The crux to being able to do this regular task is having your figures up to date and that really is not as hard as it sounds.
All of these figures will be in your accounting system.
So it’s a “no brainer” to get one implemented from the outset – see “Useful Resources” at the bottom.
Updating your accounting system is not difficult – in fact accounting is easy as I explain in just 7 tweets – CLICK to go to this thread
How can you legally take money out of your business?
Once you’ve establish how much you can pay yourself you need to formally take this out of the business so that the amount can be represented correctly in your accounting records.
For sole traders this is very straightforward – simply extract the money paying it from the business bank account into your personal bank account. Describe the amount as Drawings which is the proper accounting term to use.
For the self employed who operate via a Limited Company this is slightly more complicated as, in most cases, money will be extracted by way of a combination of dividends and salary, with the salary already being taken out of the self employed payslip calculation as an allowable expense.
Depending on your level of income there may be additional income tax to be paid on the dividends extracted. Using an online dividend tax calculator (e.g. CLICK HERE)will help you to keep an eye on how much income tax you need to pay.
This may be an area where you’d pay an accountant to advise you each year on how much to pay as a salary and help with setting up the payroll which, once you’ve grasped the basics, could be run by you through your accounting system.
Caution – you do have to make monthly returns to HMRC for payroll with fines imposed for late filing. So this really is an area where you do need to know what you’re doing.
The final thing to note is that both drawings and dividends are paid out of profits after allowing for tax (corporation tax for limited companies and income tax and Class 2 and 4 National Insurance for sole traders). Dividends and Drawings are not an allowable expense for tax purposes, something which seems to catch a few people out.
When is the tax due on the profits?
A sole trader will pay income tax on their profits by the 31st January following the end of the tax year.
A limited company pays corporation tax on profits which is due 9 months and one day after the end of the accounting period.
A shareholder may also pay additional tax on the dividends taken from the company. This will be declared on their self assessment tax return and paid by the 31st January after the end of that self assessment tax year.
What do I do with the tax money?
The best place to put your tax money is into a savings account known in some banks as a Tax Pot or Tax Vault. Although not much in the way of interest will be earned on the money set aside , the act of having it set aside ring fences it from daily use. The mindset of dipping into this pot is like taking money from HMRC should become second nature to you.
For sole traders the tax pot can be in your own name as a personal account.
For limited companies the tax pot should remain in the name of the company as removing the funds into your personal account can be seen as a payment to the director and will need to be accounted for as such by way of dividends or a loan. Better to keep things simple and set up a separate bank account in the name of the company.
Do you need an accountant?
In the past much of the accounting work would have been done by an accountant. However with the plethora of very easy to use tools around, some of which are FREE, you really don’t need to spend a fortune on accountancy fees any more. In fact the most straightforward of businesses can do the filing themselves although most will want to use an accountant simply for that “peace of mind, I can sleep at night” feel good factor of making sure that a professional has looked at things.
Useful resources
A good place to start for those new to business – TaxBootCamp.co.uk gives introductory courses for just £10 on how to smash your accounting. The courses are available online, to be taken as and when you need them. So super useful to use as a reference point.
GOV.uk for registering for your tax – it’s a bit of a disjointed web site but it is the place to go.
Caution – if you Google registering your business for tax do make sure that the web site that you go to has GOV.uk in the address. There are scammers out there pretending to be this site.
Great for Limited Companies – Mettle or NatWest to open a bank account for your business and get FreeAgent (a super easy to use accounting system) for free.
Great for sole traders – Coconut “the smart bookkeeping and tax app for sole traders” is simple to use and all that a sole trader needs to keep on top of their business, tax and your “self employed payslip”.
