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Alongside tax hikes, the UK government also provided significant tax reliefs and allowances every year, which both employed and self-employed people can benefit from. There are plenty of other means on how to reduce income tax for self-employed.
This article provides a quick information about how income tax works, focusing on self employment income tax, and details all legal means to reduce your tax bill aside from the annual personal allowance, such as contributing to a pension scheme, donating money or assets to charity, making use of tax-deductible expenses, offsetting annual losses, claiming tax overpayments, and more.
Quick Guide to Income Tax and Self Employment
| Tax Bands | Taxable Income | Tax Rates |
|---|---|---|
|
Basic Rate |
Between £12,571 and £50,270 |
20% |
|
Higher Rate |
Between £50,271 and £125,140 |
40% |
|
Additional Rate |
More than £125,140 |
45% |
| Tax Bands | Taxable Income | Tax Rates |
|---|---|---|
|
Starter Rate |
Between £12,571 and £14,732 |
19% |
|
Basic Rate |
Between £14,733 and £25,688 |
20% |
|
Intermediate Rate |
Between £25,689 and £43,662 |
21% |
|
Higher Rate |
Between £43,663 and £125,140 |
42% |
|
Top Rate |
More than £125,140 |
47% |
Throughout the UK, the standard personal allowance is set at £12,570. Tax at the higher rates differ—40 per cent and 42 per cent, respectively. As the personal allowance cannot be carried forward in the next fiscal year, you should maximise it to reduce your tax bill.
Preparing tax returns earlier is the most guaranteed method you could reduce your tax bill, as you can take advantage of all applicable reliefs, get any refund as soon as possible, manage all your finances in tax-efficient ways, and avoid any late filing penalties. Check our other article Self Employed Income Tax Rate for more information.
Understanding Tax Reliefs
In the UK, tax reliefs are either automatically applied or claimed. It may mean two things for the taxpayer: either they pay less amount to HMRC or claim repayment, a common form of which is through a personal pension or tax-deductible running costs.
When filing a tax return, self-employed individuals must check all the types of relief they may be eligible for. They may consult the government website or seek help from tax experts so that they do not miss out on every chance to curb their tax liability.
Paying Into a Pension Scheme
One of the great ways a taxpayer could reduce their tax liabilities is to join in a pension provider scheme. Making pension contributions gives them a chance to get a proportion or full value tax refund perks, whilst securing stable retirement cash flow. Currently, pension savings/ interest can be obtained at the age of 66.
The tax relief they get largely depends on which tax code their earnings belong to—the basic rate, higher rate, or additional rate—as well as the kind of pension scheme they are joining. Some types of pension schemes automatically apply the basic rate of tax relief, which is 20%, even if they pay tax more than the higher rate of 40%.
They could claim for the additional refund in their tax return through self assessment software, such as GoSimpleTax. If the reliefs are not applied automatically, they have to claim for the rest. They need to list down the gross value of their pension scheme payments when completing their self assessment tax return. Once their gross contributions are recorded, the government then gives them tax relief by adding a certain percentage or top-up to their pension.
However, not many people maximise their pension contribution relief perks than what they are entitled to. Especially if they pay tax at the higher rate of 40 per cent, pension contributors should work with tax experts to get all refunds possible.
Making Charity Donations
Donating to charity is a great way to get tax relief, applicable to both income and capital gains tax, depending on how the donation is given. It is a win-win situation for both the organisation and the director or partnership. The charity becomes better enabled for their good cause whilst higher rate payers can get something from giving.
Anyone who wants to curb their tax bill for this fiscal year should give something before the 31st of January next year—either gift aid, cash donations directly from their salary or pension savings, dividends and shares, box of items, land, or property donations, or assets from a will.
Many high earners consider Gift Aid as the very convenient course of donation, such as giving something to an amateur sports club or charity, whether item assets or money. They only have to make sure that the organisation they are donating to is authorised by the Financial Conduct Authority (FCA), which means they are already registered on the government website as part of the Gifts Aid system.
Before giving donations, they have to make a declaration proof to the organisation that they are doing this through Gift Aid so the charity can reclaim refund money on their behalf as reported in their tax returns. But they are able to claim tax relief by themselves too.
In the Gift Aid system, for every 1 penny offered to the charity, the charity could reclaim 25 penny for it. And one huge perk about donating through Gift Aid is that a person can claim tax relief on their donations not just on the previous fiscal year but up until the time they submitted their tax return if they just met the criteria.
If their donations are accepted in the Gift Aid system, it is guaranteed that the more they donate to the charity, the more they can claim for their tax relief. The rule of thumb is this—a higher rate taxpayer paying 40% of their taxes could claim 20% whilst additional rate taxpayers who pay tax at 45% could get a tax relief of 25% from their donations.
They must question the organisation for more details or seek help from tax experts to determine their refund value and the most tax-efficient method to donate according to their circumstances. This can be a complicated affair, but a tax accountant can answer every question you have and assist you all throughout.
Claiming Allowable Expenses and Any Extras
To trim their tax liabilities, self-employed individuals may want to dig further into what kinds of expenses they have allotted for their businesses are tax-deductible. These are allowable expenses that they are able to claim tax reliefs for to aid them with their company work purposes cost.
Take note that no private or personal purchases are considered allowable expenses, only company-related ones wholly and exclusively used for business purposes. Expenses vary depending on the niche, particularly where they operate—within office or at home—if they travel frequently, and more.
“Business-related costs, especially if they’re considered allowable expenses, can be deducted from their taxes.”
Self-employed persons should be familiar with allowable expenses so they would not exclude anything when filing tax return on their tax software, such as GoSimpleTax. Generally, they take into account the following costs:
- Office equipment (e.g., phone bills)
- Clothing (e.g., uniforms)
- Working from home setup (e.g., lighting, water rates, heating)
- Working on the company premises (e.g., cleaning, business rates, rent)
- Paying the staff
- Manufacturing materials
- Travel and accommodation (e.g., car fuel, parking)
- Financial matters (e.g., bank charges, insurance)
- Upskilling (e.g., training courses)
- Marketing or advertising costs
When working remotely or at home, business and personal expenses should be separate. For example, self-employed individuals who work remotely in the UK specifically designate a room or more for an office. Another example is to base the cost on the number of hours they spent working from home.
Upskilling themselves or their workers is another practical way to lessen their tax bill, especially if they take business-relevant refresher or training courses vital to keep them updated and secure in their professional position.
Especially when they travel often for business, they must also list down the amount they spend on travel and accommodation, including their trips from one place to another and vehicle-related expenses, for example, petrol, maintenance, or insurance.
Take note that when the vehicle is also used for private purposes, documentation of their business mileage is necessary. Transportation-related allowable expenses do not include the mileage between their business premises and home, how much their vehicle costs, and meal expenses.
However, when the range of allowable expenses stops, capital allowance comes in, which applies to those who still use traditional accounting. Capital allowances refer to the purchases essential to keep the company operations. These allowances take into account how much the business spends in purchasing their vehicles, machinery, and equipment.
Claiming allowable and capital allowances can be hassling, but there is one key answer for both sole trader and business partner. The key is using simplified expenses and working out a flat rate. It is better to work around these allowances with the help of a tax accountant to ensure accuracy and get the maximum amount of tax relief.
Offsetting Annual Losses
Whether a sole trader or a limited company owner or partner, self-employed individuals are bound to face challenges in their trade at some point, especially losses. These cash flow obstacles happen when their capital allowances and tax-adjusted expenses exceed their total profits for that fiscal year. Ultimately, for that accounting year, it is referred to as an annual loss.
A lot of trade dealt with these challenges, especially during the pandemic, which has proven to be one of the toughest times in history. If for some other reason they are dealing with money losses, they need to be aware of the various means to claim their tax relief and offset its effects.
“Make losses less painful by offsetting it in various ways.”
If they just met certain criteria and reached a time limit, they can eligibly claim one of the means, a common form of which is getting a refund or a decrease of their income tax liabilities.
Disclaimer: To determine the applicable method on claiming relief for their annual losses—such as forwarding the losses to a more successful year, setting it on another taxable income, or backtracking it to the last year—opting for tax experts’ counsel can prove to be priceless. These experts provide substantial advice on which means would best apply in their circumstances.
Claiming Against the Last Tax Years
Overpaying taxes can always happen, so once taxpayers come across this kind of situation, they need to act on it right away so they can at least trim their tax obligations for the next fiscal year. The maximum number of years they can backtrack and claim any surplus paid taxes for is four fiscal years.
They must note any mistake in the last tax return they submitted, then inform HMRC about it so they can start requesting the overpayment relief of their surplus tax upon completing their self assessment tax return.
They need to provide signed proof for the surplus payments to make a legitimate declaration of their claim then choose how they want to receive the reimbursement.
Reducing Income Tax with the Help of Tax Professionals
Next year’s tax liabilities would be less burdensome for taxpayers when they prepare their self-assessments way ahead of time and especially with the help of a tax accountant. Listed above are just a few amongst plenty of other means to lessen their tax liabilities.
Legend Financial provides expert guidance on how to reduce income tax for self-employed. Having served in the industry for more than a decade, we are well-versed in the field. We have assisted hundreds of clients in optimising their tax and financial affairs. Reach us today!
References
Tax relief on pension contributions. (n.d.). Retrieved from Money Helper: https://www.moneyhelper.org.uk/en/pensions-and-retirement/tax-and-pensions/tax-relief-and-your-pension#:~:text=If%20your%20workplace%20pension%20uses,having%20a%20lower%20tax%20bill.
Claim Income Tax reliefs. (n.d.). Retrieved from gov.uk: https://www.gov.uk/income-tax-reliefs/charity-donations-tax-relief#:~:text=payments%3A%20tax%20relief-,Charity%20donations%3A%20tax%20relief,or%20pension%2C%20through%20Payroll%20Giving
Tax relief when you donate to a charity. (n.d.). Retrieved from gov.uk: https://www.gov.uk/donating-to-charity
Tax-effective giving to charity. (n.d.). Retrieved from CAF: https://www.cafonline.org/my-personal-giving/plan-your-giving/tax-effective-giving
Ten easy ways to cut your tax bill. (n.d.). Retrieved from The Times: https://www.thetimes.co.uk/money-mentor/article/ten-easy-ways-to-cut-your-tax-bill/
Self-employed? Here are four tips to cut your tax bill. (n.d.). Retrieved from HL: https://www.hl.co.uk/pensions/insights/self-employed-tips-to-help-cut-your-tax-bill
35 ways to save on tax. (n.d.). Retrieved from Which: https://www.which.co.uk/money/tax/saving-on-tax/35-ways-to-save-on-tax-a18nb3s9144f#headline_1
Self-employed expenses you can claim. (n.d.). Retrieved from Which: https://www.which.co.uk/money/tax/income-tax/income-tax-for-the-self-employed/self-employed-tax-allowable-expenses-aitJk9V1pb1g
Expenses if you’re self-employed. (n.d.). Retrieved from gov.uk: https://www.gov.uk/expenses-if-youre-self-employed
HOW TO REDUCE YOUR TAX BILL IF YOU’RE SELF-EMPLOYED. (n.d.). Retrieved from Go Simple Tax: https://www.gosimpletax.com/blog/reduce-self-employed-tax-bill/
What you need to know when claiming tax relief for self-employed losses in 2020/21. (n.d.). Retrieved from Low Incomes Tax Reform Group: https://www.litrg.org.uk/latest-news/news/211216-what-you-need-know-when-claiming-tax-relief-self-employed-losses-2020-21
