Tax for self-employed individuals
Self-employed UK individuals earning more than £1,000 per year must register with HMRC for self assessment (SA) and file an annual SA tax return. You can register for SA using your personal tax account with HMRC and submit your tax returns electronically. The HMRC website link to register for a personal tax account is:
Personal tax account: sign in or set up – GOV.UK (www.gov.uk)
PAYE and national insurance
As a self-employed UK individual, you’ll need to pay income tax or PAYE on your net income for the year (sales minus expenses). After deducting the personal allowance of £12,570, your remaining income is taxed at your applicable tax band rate. Furthermore, Class 4 national insurance of 6% is payable on income between £12,570 and £50,270. Class 4 national insurance of 2% is payable on profits over £50,270. The tax year runs from 6th April to 5th April of the following year.
Voluntary NI contributions
Class 2 national insurance contributions of £3.45 per week are abolished from April 2024. If your profits fall below the threshold of £6,725 you can make voluntary Class 2 national insurance contributions to avoid gaps in your national insurance. This maintains your entitlement to the basic state pension, bereavement benefits, maternity allowance and contributory employment and support allowance (ESA).
Tax for company directors
For company directors, the tax situation is slightly more complex compared to that of a self-employed individual. Directors can pay themselves through the payroll and draw dividends from the company’s post-tax profit. The corporation tax rate for companies varies from 19% to 25% depending on their net profit. Companies with an annual net profit of £50,000 or less pay 19% tax, while those with net profits between £50,000 and £250,000 pay tax at a marginal rate between 19% and 25%. Companies making over £250,000 pay a flat 25% tax.
As a director, the salary paid to you is subject to PAYE and employee national insurance. Additionally, the company will pay the employer national insurance on the salary. These payments are business expenses and are deducted from the company’s income, decreasing its net profit and corporation tax liability.
Dividends and tax
Dividends withdrawn from after tax profits are taxed based on the income tax band determined by the director’s total income. After deducting the dividend allowance, dividends within the basic tax rate band are taxed at 8.75%, those in the higher tax band are taxed at 33.75%, and those in the additional tax band at 39.35%. Tax on dividends is paid through an individual’s annual self assessment tax return. For example, individuals earning less than £50,270 in combined income and dividends pay 8.75% dividend tax. When dividends and income exceed £50,270, dividends above this amount are taxed at 33.75%. All individuals have an annual dividend allowance of £1,000, allowing tax-free dividends up to this amount.
Illustration of director’s tax
As a director and employee of a limited company, you will pay several taxes, including corporation tax, PAYE, employee and employer’s national insurance contributions, and dividend tax.
Let’s assume a company has net profits of £40,000. The corporation tax payable will be £7,600 (£40,000 x 19%). After corporation tax, the remaining reserves are £32,400, which are available to be withdrawn as dividends. The director takes a salary of £20,000, incurring PAYE of £1,486 and employee NI contributions of £594. The employer national insurance is £1,505. Finally, the director withdraws £32,000 as dividends from the remaining business reserves.
The first £1,000 of dividends is tax-free. The remaining £29,270 of dividends are taxed at 8.75%, which is £2,561. The remaining £1,730 of dividends fall in the higher tax band rate and are taxed at 33.75%, which is £584. The director’s total income is £52,000, with £1,730 being above the basic tax band limit of £50,270.
The total tax liability for the director is £14,330, consisting of:
- Corporation tax of £7,600
- PAYE of £1,486
- Employee national insurance of £594
- Employer’s national insurance of £1,505
- Dividend tax of £3,145
