Freelancers and the self-employed often face unique challenges when it comes to tax planning. Unlike traditional employees, you don’t have the security of a regular pay cheque or automatic deductions for things like income tax or national insurance. Instead, you’re responsible for managing your own taxes, which can be a daunting task.
We know it can feel overwhelming at times, but there are strategies that can help you make the most of your income, ensure you’re paying the right amount of tax and even save money in the long run. Let’s explore some key tax planning strategies to keep in mind as you manage your finances this tax year.
Understand allowable expenses
One of the biggest advantages of being self-employed is the ability to claim tax deductible expenses. These are costs that you can subtract from your income to reduce the amount of tax you owe. But it’s important to know exactly what qualifies as an allowable expense.
Typical deductible expenses for freelancers include office supplies, travel costs, marketing and insurance. If you work from home, you can also claim a portion of your household bills, such as utilities and rent or mortgage interest. For instance, if you use a specific room as your office, you can claim a percentage of your home expenses based on how much of your house is used for business.
Remember that to claim these expenses, they must be wholly and exclusively for business purposes. If you mix personal and business use (for example, a phone you use for both work and personal calls), you can only claim the percentage related to your business.
Stay on top of irregular income
One of the trickiest parts of freelancing or being self-employed is dealing with irregular income. Your income might fluctuate from month to month, making it difficult to budget for tax payments. Fortunately, there are ways to manage this effectively.
The key is to plan ahead. Setting aside a portion of your income every time you get paid is crucial. It’s often recommended to save at least 25-30% of your income for taxes to cover both your income tax and national insurance contributions. By doing this consistently, you’ll avoid any unpleasant surprises when your tax bill comes due.
For those whose income varies from year to year, it is possible to reduce your “payments on account” which are the advance payments towards your tax bill, one in January and one in July. These are based on your previous year’s earnings and so if you are forecasting lower taxable profits you can reduce the advance tax payments. Beware that if you reduce them too much then interest will be payable on any eventual underpayment when your final tax bill is calculated.
Take advantage of tax credits
Many freelancers and self-employed individuals aren’t aware of the tax credits that could reduce their overall tax liability. One such example is the marriage allowance, where a lower-earning spouse can transfer £1,260 of their personal allowance to their partner, potentially reducing their tax bill by up to £252. If your spouse or civil partner earns below the personal allowance threshold (£12,570 in the 2024/25 tax year), this is worth considering.
If you’re investing in your business, you might also be eligible for the annual investment allowance (AIA). This allows you to claim up to £1m in capital allowances for qualifying business equipment purchases, such as computers, machinery or office furniture. It’s a valuable tool for those making significant investments in their business.
Use pension contributions to reduce your tax bill
Another effective strategy for freelancers and self-employed individuals is to contribute to a pension. Not only does this help secure your future, but it also provides immediate tax benefits. Contributions to a personal pension are tax-deductible, and you can receive tax relief at your highest rate of income tax.
For example, if you’re a basic-rate taxpayer, you’ll receive 20% tax relief on your contributions. For higher-rate taxpayers, this increases to 40%. It’s a great way to reduce your tax bill while also setting money aside for your retirement.
Additionally, for those with higher incomes, making pension contributions can help bring your taxable income below certain thresholds. For instance, if your earnings exceed £100,000, your personal allowance is gradually reduced. However, pension contributions can help keep your income within the limit, allowing you to retain your full personal allowance.
Consider the benefits of incorporating
Many freelancers start as sole traders, but as your business grows you might benefit from incorporating as a limited company. One of the main advantages of this is the potential tax savings. As a sole trader, you’re taxed on all your profits through income tax and national insurance. However, if you operate as a limited company, you can pay yourself a combination of salary and dividends, which is often more tax efficient.
The current corporation tax rate is 25% (as of the 2024/25 tax year), which could be lower than the income tax rate for higher earners. Additionally, dividends are taxed at a lower rate than employment income. However, incorporation comes with its own responsibilities, such as additional administrative duties and the need to file annual accounts, so it’s important to weigh the pros and cons.
Plan for the long-term
Effective tax planning isn’t just about reducing your tax bill in the short term – it’s about setting your business up for long-term success. This means keeping detailed records, staying on top of deadlines and regularly reviewing your financial situation.
We understand that tax planning can feel like a burden, but it’s something we can help with. At Pearson May we’ve been supporting freelancers and self-employed individuals for over 180 years, and we’re here to provide personalised advice that helps you save time, money and stress.
Come to us for further advice
Whether you’re just starting out as a freelancer or have been self-employed for years, tax planning is essential to managing your finances effectively. By understanding allowable expenses, planning for irregular income and making the most of tax credits and deductions, you can ensure that you’re not paying more tax than you need to.
If you’d like to learn more about how we can help, don’t hesitate to get in touch. At Pearson May, we’re here to make tax planning simple, efficient and tailored to your unique situation.