Working as a freelancer or contractor in the UK can be rewarding, but it also comes with important tax considerations. As a self-employed individual, you are responsible for handling your taxes and national insurance contributions. Knowing how to account for taxes properly can help you maximize your income and avoid penalties. 

Self-Employment Tax Basics

When working for yourself, you are considered a sole trader by HMRC. This means you need to file a Self Assessment tax return each year reporting your income and expenses. Your taxable profits are then subject to the following:

• Income Tax: You pay income tax on your profits at the standard personal tax rates ranging from 20% to 45%, depending on your total taxable income level for the year.
• National Insurance Contributions (NICs): Class 2 NICs are a flat weekly fee for all sole traders (£3.15 per week in 2022-23). Class 4 NICs are an additional 9% of your profits between £9,880 and £50,270, then 2% on profits above £50,270.
• Dividend Tax: If operating through a limited company, you’ll pay dividend tax on profits you extract, usually at a 8.75% basic rate, 33.75% higher rate, and 39.35% additional rate.

Claiming Allowable Expenses

You can deduct any allowable business expenses from your income as a freelancer before calculating your tax liability. Allowable expenses include things like:

• Office supplies and software
• Travel and mileage costs
• Accounting/legal fees
• Phone, internet, and utilities
• Training and continuing education
• Equipment purchases
• Rent, insurance, interest (if working from home)

Tracking expenses carefully and claiming all available deductions is crucial to reducing taxable income. You should keep records of all receipts and expenses incurred for your freelance or contracting work.

Limited Company Benefits

Setting up a limited company makes sense once your self-employed income reaches a certain level. Some key tax advantages of a limited company include:

• Lower NICs: Company owners pay Class 1 NICs of 13.8% on salaries up to £50,270, while dividends are not subject to NICs.
• Tax-free Dividends: The first £2,000 of dividends you extract each year are tax-free. Additional dividends fall under the lower dividend tax rates than income tax rates.
• Tax Deductions: You can claim more expenses before tax by deducting costs from the company profits first.
• Flexible Income: You can optimize taxes by adjusting your salary versus dividend amounts.
• Lower Tax Rates: The 20% corporation tax rate is lower than higher income tax rates.

Optimum Income for a Limited Company

Our Tax Experts recommend considering a limited company once your self-employed profits reach around £40,000 to £50,000 per year. This income level is when a company structure’s NIC savings and other benefits typically outweigh the additional admin costs and complications.

The exact income tipping point varies based on your circumstances. But here is a general guide:

• £25,000-£30,000: Should start weighing up the pros and cons of a company
• £35,000-£40,000: Likely start seeing net benefits from a company structure
• £50,000+: Almost certainly worth using a company from a tax perspective

It’s smart to consult our specialist accountant when deciding whether to form a limited company. We can review your situation and advise if and when switching makes the most tax sense. Our accountants can also help handle the company setup process and manage your accounts and taxes going forward.

Maximizing your income as a freelancer or contractor in the UK requires staying on top of your tax obligations. Understanding the implications around income tax, NICs, allowable expenses, dividends, and company structures is key. With the right tax strategy, you can take advantage of all available deductions, lower your tax burden, and ultimately keep more of your hard-earned income.