Tax doesn’t have to be taxing. But it does have to be paid.
And many self-employed people fail to put aside enough each year to cover the bill.
Unlike employees, where tax is taken off before you receive your pay packet, freelancers are usually paid gross (pre-tax).
But the psychology of this can cause financial havoc.
Change your mindset
If you receive £100, it’s easy to think all that money is yours – and that tax is just another bill to sort out in the distant future.
But it can be devastating – not to mention financially crippling – to find out that when the time comes you don’t have enough to cover it.
One way to protect yourself against this is to set up a savings account.
Divide your payments by three. You keep a third and the rest goes into the savings scheme.
So for every £100 you receive, at least £30 you put away.
Using a high interest savings account or an ISA will mean you are earning interest on your savings.
It will also help you to plan ahead so you have enough for tax as well as National Insurance contributions. You might even find you have a little left over to treat yourself for your prudent financial management.
What else can you do?
Another effective way to protect yourself from an annual personal tax shock is to set yourself up as a limited company.
This is very simple to do and takes very little time.
While sole traders pay income tax, companies pay corporation tax. But while corporation tax rates are lower than income tax rates the advantage lies with incorporation.
As well as salary payments to employees, a company can also pay dividends to its shareholders. A shareholder director (you) can therefore choose to receive the most tax efficient mix of salary and dividends.
This effectively means that you can manage your money, paying yourself a wage from your company as well as expenses.
Any profit leftover at the end of the year in your business account will then be liable for corporation tax.
If you would like any advice on how to set up a limited company, give us a call today.