A guide to paying freelance tax
Freelancers are an important part of the UK economy. Figures from the Association of Independent Professionals and the Self-Employed (IPSE) show there were more than 2 million freelancers in the UK in 2023 and they contribute an estimated £169 billion to the economy.
Freelancers enjoy the flexibility of working for themselves and a variety of clients, but there are several tax rules they need to follow.
Those rules have got increasingly complex over recent years thanks to the government’s off-payroll working legislation.
What is a freelancer?
A ‘freelancer’ is someone who works for themselves who often sell services and deliver projects on a contract-by-contract basis for several clients. Examples include freelance writers and graphic designers. Other terms used are contractors and consultants.
Freelancers are self-employed and are responsible for their own taxes, which can include income tax, National Insurance Contributions (NICs), and Value Added Tax (VAT).
usiness Structure: Sole Trader, Limited Company, or Umbrella Company?
When it comes to business structure, freelancers can operate in a variety of business structures. Each structure has its own advantages and disadvantages including:
- Sole trader: A sole trader is a self-employed individual who runs their own business. A sole trader is the simplest business structure but as the business is not a separate legal entity to its owner, sole traders are personally liable for all business debts so their personal assets could be at risk if they are unable to pay creditors.
- Personal service company (PSC): This is a limited company set up by a freelancer or contractor to provide services. A personal service company is usually a company set up with a sole shareholder and director who is the person providing services. Unlike sole traders, a limited company is a distinct legal entity that is separate from its shareholders and directors. This means they are only responsible for the amount of money that they put into the business.
A PSC, however, may fall under IR35 or ‘off-payroll’ rules. IR35 anti-avoidance tax legislation designed to tax people who use PSCs to work as ‘disguised’ employees and pay less tax. If a PSC is covered by IR35 or ‘off-payroll’, more tax and National Insurance will generally be due. - Umbrella company worker: An umbrella company is effectively the employer of a freelancer or contractor. They operate a payroll on the salary paid to the freelancer or contractor. Using an umbrella company usually leads to higher tax and National Insurance deductions compared with a PSC.
An accountant can advise on whether you should operate as a sole trader, limited company or use an umbrella company.
How does freelance tax work?
Freelancers operating as a sole trader pay personal income tax on trading profits at a rate of up to 45% (48% in Scotland). Where you operate as a limited company, the company must pay corporation tax at either 25%, or 19% on company profits. You also have to pay income tax on amounts extracted from your limited company.
Sole traders pay income tax on operating profits, which is their total earnings minus eligible business expenses.
The rate of income tax you pay is dependent on how much you earn and what tax band you are in. See the next section below for more details.
Freelancers also pay National Insurance Contributions.
Freelancers operating as a limited company pay corporation tax on trading profits after allowable business expenses have been deducted. They also pay income tax and National Insurance on a salary they receive through the company. While salary is a reward for effort, shareholders in a company are also entitled to a reward for investment. After paying the directors’ wages, any surplus funds can be drawn as dividends, which are subject to income tax. These can only be paid from company profits after corporation tax.
How much can you earn freelance before paying tax?
Freelancers operating as a sole trader pay income tax on trading profits above the personal allowance of £12,570 at rates of up to 45% (48% in Scotland). Those running a limited company pay income tax on any salary and dividends they take from the business.
Income tax rates for 2024-25 are as follows:
England, Wales and Northern Ireland
| Tax band | Taxable income | Tax rate |
|---|---|---|
| Personal allowance | Up to £12,570 | 0% |
| Basic rate | £12,501 to £50,270 | 20% |
| Higher rate | £50,271 to £150,000* | 40% |
| Additional rate | Over £150,000 | 45% |
*The personal allowance reduces by £1 for every £2 of income above £100,000.
Scotland
| Tax band | Taxable income | Tax rate |
|---|---|---|
| Personal allowance | Up to £12,570 | 0% |
| Starter rate | £12,571 to £14,876 | 19% |
| Scottish Basic rate | £14,877 to £26,561 | 20% |
| Intermediate rate | £26,582 to £43,662 | 21% |
| Higher rate | £43,663 to £75,000 | 42% |
| Advanced rate | £75,001 to £125,140** | 45% |
| Top rate | Above £125,140 | 48% |
**There is no personal allowance for income above £125,140.
Limited company directors pay income tax on any salary that they take from their business at the above rates. Where they decide to withdraw part of the profits as dividends, they must pay income tax on these dividends.
The dividend allowance applies a nil rate of tax on the first £500 of dividends.
Beyond that, the dividend tax rates are as follows:
| 2024/25 | 2023/24 | |
|---|---|---|
| Basic rate taxpayer | 8.75% | 8.75% |
| Higher rate taxpayer | 33.75% | 33.75% |
| Additional rate taxpayer | 39.35% | 39.35% |
For more details of the tax do you pay on dividends, please click here.
National Insurance payments
As well as being liable to pay income tax, freelancers will also need to pay National Insurance Contributions (NICs).
There are a number of types of NICs that apply to freelancers, dependent on how they are running their business and if they are impacted by IR35 or ‘off-payroll’ rules.
National Insurance does not apply to dividend income.
National Insurance classes are as follows:
| National Insurance class | Who pays |
|---|---|
| Class 1 |
Employees under state pension age who earn above a certain threshold pay class 1. They are automatically deducted by the employer. Directors in limited companies pay NICs in a different way to employees, on what is known as an annual basis. This means NICs are calculated using their annual earnings rather than from what they earn in each pay period. It should also be noted that employers must also pay employer contributions for each employee and more details about the employer contributions which may be due can be found here. Taken together, the employee and employer NICs charges create a significant liability for contractors under IR35, ‘off-payroll’ or umbrella workers. |
| Class 1A or 1B | Paid directly by employers on their employees’ expenses or benefits. |
| Class 2 | Self-employed individuals earning profits of £6,725 or more are no longer required to pay class 2 NIC. Those earning below £6,725 may wish to make voluntary contributions. |
| Class 3 | These are voluntary contributions that can be paid to fill or avoid gaps in the individual’s NIC record. |
| Class 4 | The self-employed also pay NICs on an annual basis as Class 4 NICs. |
As mentioned, dividends do not attract NICs and extracting profit as dividends can create tax and NICs efficiencies.
What is IR35?
IR35 describes a set of rules that aims to combat alleged tax avoidance by contractors and the clients they do work for.
The IR35 rules look at whether the contractor should be be considered an employee if the intermediary was not used. If the contractor is found to be what is known as a ‘disguised employee’ and inside IR35, the rules broadly require that the contractor must pay income tax and NICs as if they were an employee.
Since 6th April 2021, medium and large-sized end users of labour have been responsible for determining the employment status of contractors.
Medium and large enterprises are defined as those that meet two or more of the following:
- have an annual turnover of more than £10.2 million
- have a balance sheet total of more than £5.1 million
- have more than 50 employees
Smaller businesses that don’t meet the above conditions are exempt from the rules and the contractor remains responsible for determining whether they are inside or outside of IR35.
Since 6th April 2017, all public sector organisations have been responsible for deciding if the off-payroll working rules apply to contracted workers providing services through an intermediary.
IR35 is complicated to understand so it is advisable to get help from a professional.
How to pay tax on freelance work
Freelancers pay tax on their personal income after submitting an annual self assessment tax return. If you run a limited company, you also need to pay corporation tax as well as file a company tax return and company accounts.
You must register as self-employed with HMRC by 5th October after the end of the tax year during which you became self-employed.
You need to file a self assessment tax return online and pay any tax due by 31st January, following the end of the relevant tax year. You face financial penalties if you miss the deadline so there are many benefits to filing a tax return early.
A freelancer’s tax bill is generally paid in two instalments by 31st January and 31st July each year. These are known as ‘payments on account’. Each payment on account is broadly 50% of the prior year’s income tax. If you operate through a limited company, you need to submit a company tax return to work out your corporation tax bill.
Limited company directors are also required to file company accounts with Companies House and submit a personal self-assessment tax return that outlines the salary and dividends received through the company.
Freelancers turning over £90,000 of taxable supplies must register for Value Added Tax (VAT) where your total VAT taxable turnover for the last 12 months was over £90,000 or you expect your turnover to go over £90,000 in the next 30 days. VAT is generally paid by submitting quarterly VAT returns.
The process of paying tax can be complex so to ensure the accuracy of the information that you send to HMRC and that you maximise the benefits of tax reliefs and allowances, it is recommended that you speak to your accountant for advice.
What expenses can I claim as a freelancer?
HMRC allows self-employed business owners to deduct certain business expenses to reduce the trading profit on which they are taxed. You should keep accurate records of all business expenses.
Many freelancers work from home. In this case, the rules allow you to claim tax relief on part of your household expenses.
Allowable expenses for freelancers include:
- office supplies, such as stationery
- travel, such as fuel, train and bus tickets
- business premises, such as heating and business rates
- training courses related to your business
- staff, such as salaries
- marketing and advertising, such as website charges
- financial, such as insurance, accountancy and bank charges
The rules are slightly different for limited companies but all expenses must generally be incurred “wholly and exclusively” for the day-to-day running of your business.
Making sure you claim all the deductible allowances and reliefs that you are entitled to is a crucial element of tax planning. It is recommended that you speak to your accountant to ensure you maximise the benefits.
Need help with your freelance tax?
For assistance with your tax obligations as a freelancer, book a free consultation by calling 01522 699870 or contact us using our online enquiry form.
Last updated: 15th July 2024