In the United Kingdom, freelancers are subject to specific tax regulations that have evolved in recent years. Here’s what you need to know.
Income Tax and National Insurance Contributions (NICs)
Sole Traders: Freelancers operating as sole traders are liable to pay income tax on their business profits, which is calculated as total earnings minus allowable business expenses. The personal allowance, which is the amount of profit exempt from tax, is set at £12,570. Earnings above this threshold are taxed at rates of 20%, 40%, and 45%, depending on the income bracket. Additionally, sole traders must pay Class 2 and Class 4 NICs, contributing to state benefits and pensions.
Limited Companies: Freelancers may choose to operate through a limited company, which is subject to a 19% corporation tax on its profits. When extracting profits, individuals may face further taxation, such as dividend tax, depending on the method of withdrawal.
IR35 Legislation
The IR35 rules, officially known as the “off-payroll working rules,” are designed to assess whether a freelancer is genuinely self-employed or operating as a “disguised employee” to benefit from tax advantages. If caught by IR35, the freelancer must pay income tax and NICs similar to an employee, without receiving employment benefits. In April 2017, reforms shifted the responsibility for determining IR35 status from the individual to the client in the public sector, and in April 2021, this was extended to medium and large private sector clients.
Recent Developments:
The 2024 Autumn Budget introduced several measures impacting freelancers:
Employers’ National Insurance Increase: A 1.2 percentage point rise in employers’ NICs may influence hiring practices, potentially affecting freelancers and contractors.
Tax Threshold Adjustments: Changes in tax thresholds could alter freelancers’ net income, depending on their earnings.
Tax Compliance and Tools
HM Revenue & Customs (HMRC) has launched tools to assist individuals in determining their tax obligations, especially concerning additional income from side activities. Accurate reporting is crucial to avoid penalties.
Freelancers in the UK must navigate a complex tax landscape, balancing income tax, NICs, and compliance with IR35 regulations. Staying informed about legislative changes and utilizing available resources is essential for effective financial management.