Paying tax on earnings is an inescapable part of life for most of us. Though individuals have an initial personal allowance of £11,500 on which they do not have to pay tax, most people in full-time employment will be earning more than this and will have to pay varying rates of tax on their income. How you earn a living will affect how you pay tax, and it is important to make sure you meet your tax obligations.
How tax applies to different career roles
For many people, thanks to the pay as you earn (PAYE) system, paying tax is not something they have to think about. A salaried employee’s tax and National Insurance contributions are deducted each month by the employer from gross pay, with the remaining net amount being credited to the employee. Those employees rarely need to communicate with HMRC regarding their tax affairs.
Personal taxation becomes more complicated when an employee has a fluctuating level of income, for example, sales people who earn commission, as high commission payments can shift them into a different tax bracket, which could mean they retain less of their commission than they expected. Nonetheless, if it is the only income in question and as long as the worker does not change jobs, the tax due will be automatically deducted.
Taxation for the self-employed and sole traders
The way you deal with tax liability is different when you are providing your services to various employers as a self-employed individual, or you are running your own business as a sole trader. Self-employed workers – whether you are self-employed for your main job, or have a second income – must file tax returns with HMRC. You are responsible for keeping some of your earnings aside at the end of every month so that you have funds available to meet your tax obligations.
Self-employed workers have to pay income tax as well as National Insurance contributions the same as any other employee. The tax payable is calculated by using the self-assessment system now accessible online at the HMRC website. The individual or his/her accountant completes the online forms giving details of income and allowable expenses. The tax liability is then automatically calculated. Both self-employed workers and sole traders can reduce their tax liability by deducting the allowable expenses they incur through their work; accountants can offer good advice on how to minimise your tax bill.
Working as a contractor and the tax implications
Many workers have opted to work as contractors to enjoy the tax advantages associated with not working as a full-time employee, but the relevant tax laws have changed over the years. Contractors need to be aware that the IR35 ruling is, in particular, designed to stop workers who are effectively working as full-time employees from enjoying tax advantages via contracting. Contractors that need help with IR35 and paying taxes should think about working via an umbrella company as this greatly simplifies the administration of personal tax affairs.
It pays to keep your tax affairs in order
HMRC takes tax avoidance very seriously. Even if you are employed as a full-time, salaried worker it is worth keeping an eye on your payslip to ensure you are paying the right amount of tax, as occasionally, HR departments and even HMRC can get the tax codes wrong. It is highly likely that HMRC will pursue you and impose fines and penalties if you underpay your tax, so independent workers, in particular, should be meticulous when filing their tax return. It must also be filed before the deadline for submission set by HMRC or a fine will be imposed.