The financial challenges of freelancing are often a burden most people don’t anticipate. Over the years, the prices charged are increasing faster than the personal tax rate bands. As a result of this, freelancers who would have been taxed at 20% are now finding themselves taxed at 40% and in some cases even 45%. Considering how freelancers save on taxes is something that all businesses need to think about regularly. Understanding freelancer tax tips can be crucial to managing these changing tax liabilities.
Keep Detailed Financial Records
Effective tax planning isn’t completed at the end of the tax year, it’s completed by regularly assessing your finances and adapting to what your numbers are showing you. To do this effectively, you need to be tracking your income and expenditure accurately.
This doesn’t mean that you should keep your documents in a folder for your accountant at the end of the year. You need to be proactive by having your financial information readily accessible in a digital format. This allows for proactive tax planning of the back of reviewing the data.
We tend to find the easiest systems to use for tracking your monthly finances are, Xero, QuickBooks or Sage. However, you can just as easily track your position with a well designed excel sheet as well.
Consider Setting Up a Limited Company
An individual freelancer is subject to larger swings in tax rates than that of a freelancer operating as a limited company. For example, individuals will pay income tax on their profits at 20%, 40% and/or 45%. As well as having to pay national insurance on their overall profits too.
A company will only pay corporation tax on their profits at 19% or 25% (simplified). As well, companies are not subject to national insurance liabilities.
Straightaway we can see that in most cases, operating as a limited company is more tax effective than operating as an individual. This form of tax planning is often overlooked as emphasis is usually placed on reducing profits to save tax whereas this option does not change your profit figure, but instead changes the tax rate your profits are subject to.
Now it’s not that straightforward, everyone’s personal circumstances need to be considered. However, the bases are usually that a limited company is more beneficial as an operating method for tax saving purposes than operating as an individual.
Expenses Will Reduce Your Tax Bill
A common misconception is that tax planning involves buying laptops or cars to bring your tax bill down. This is not tax planning. Yes, those could qualify for tax deductions and reduce your overall tax liability. This reduction in tax is due to the expenditure reducing your final annual profit figure. The lower your profit, the less tax you pay.
Which I get may seem like tax planning. However, if you’re only making the expense for the sake of reducing your tax position then you’re technically worse off from a cash perspective than if you just paid the original tax liability in the first place.
It’s important to know how freelancers save on taxes by leveraging allowable expenses. When it comes to expenses, you will find that you naturally spend on the goods and services your business needs to operate. Tax planning is then built around this natural position.
A common example of what we would consider unnatural spending would be pension contributions. Making a pension contribution is not consider a running cost for your business. i.e. the business would likely achieve the same turnover and job completion with or without the pension contribution being made. This is usually the first form of tax planning businesses have.
When making a pension contribution, your business is able to reduce its annual profits by the amount contributed, hence reducing the tax liability and further to this, you personally have ownership of the money without a personal tax hit.
Plan for Taxes Throughout the Year
Proactive planning is the most effective way to assist with tax planning throughout the year. This means using software to capture your monthly income and outgoings and having your accountant complete a monthly or a quarterly check-in. As a part of these check-ins, your accountant can take your bookkeeping work and prepare management accounts. Which form the basis for tax panning.
Without having the data readily available, you could, delay the tax planning process be having to spend more time calculating your financial position, or end up with inaccurate tax planning being performed.
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