As a sole trader or partnership your profits are taxed as any other income by the HMRC. And as you are self-employed your tax will be self-assessed.

The amount you owe is calculated after business expenses and personal allowances have been deducted. Your income will fall under tax Schedule D and as you will be paying income tax twice a year so it makes sense to put money aside.

As a self-employed person many of your business expenses can be deducted from your taxable income, such as overheads on your premises, travel, delivery costs and trade association subscriptions. But you will have to pay capital gains tax if you sell or give away any assets.

You will also be paying National Insurance Contributions (NICs) to the Department of Social Security. Class 2 NICs are charged at a small weekly rate and the level of Class 4 contributions you pay depends on your profits.

Some individuals, if their income is above a certain level, (approximatley £67,000 per annum, although this is subject to Budget announcements) must apply for value added tax (VAT) registration. This means you will be collecting VAT from your customers and paying it to HMRC less the VAT you have paid out in the course of business.

Registering as self-employed

If you make all or part of your living by working for yourself – not through a salary or commission from an employer – then you’re considered self-employed. If you are self-employed your tax and national insurance contributions are not paid at the time you receive payment, and you are therefore bound by law to declare your earnings to HMRC.

If you receive any payment for a service you have provided or a business you operate, this requires you to register with HMRC, but does not necessarily mean you earn enough to require you to pay tax.

You must register as self-employed within the three months of starting trading otherwise you will be liable to pay a £100 fine. Click here to fill out the online form to register as self-employed.

The increase in popularity of online businesses had led to an increasing number of people setting up part-time businesses for additional income to their main job. As a result, many people are unsure what they have to declare for tax purposes and at what point they should register as self-employed.

When does selling a few items on eBay turn into a business, and therefore a taxable activity? HMRC rules stipulate that all e-traders must be registered with them so that their income can be taxed.

You are an e-trader if you:

• Sell goods that were bought with the intention of re-selling them.
• Sell items you made yourself for a profit.
• Sell or buy on behalf of others for financial gain.
• Receive payment for a service

If you can answer yes to any of these questions then you must register as self-employed with HMRC within the three-month deadline. With regards to eBay, it is extremely unwise to delay registering, as HMRC carries out checks on online auction sites to root out members who process a high number of transactions.

Tax for home workers

Mention the spectre of self-assessment to any seasoned self-employed person and they will probably look at you with a wry smile. Most feel that the rest of the world is just catching up with what they have been going through for years.

Dealing with the taxman is just one of the burdens of self-employment - unless you are an accountant, of course.

Working at home, with no-one else to bounce things off, can be made much more difficult after the thump on the doormat brings you another baffling tax form.

Seek help

If you are one of those whose eyes glaze over at the very mention of tax and if you are one whose brain goes into a thick fog at the sight of a tax return, the best advice is to seek help. Accountants may seem an expensive luxury at first glance but a year down the line they should be more like money well spent.

Apart of saving you a lot of headaches, a good accountant will probably save you money in unnecessary tax. They know all the allowances and legitimate expenses and will make sure you claim back all that is your right.

It can also save headaches with the taxman. Using an agent known to the tax office gives you credibility. The taxman knows the agent is not going to be “cooking the books” and therefore may be quicker to accept the figures. And if you are launching from home, talk to an accountant before you start. It is no good waiting for the first year to come and go and then discover a few tips that would have saved you money.

An accountant will be able to advise whether or not you are better off to launch as a limited company or to operate as a sole trader. They will also advise on partnership issues and should generally steer you in the right direction.

More advice may well be needed if you are looking for capital with which to launch your business. Your accountant may help with a business plan and suggest tax effective ways of seeking backing.

A lot will depend on the type of business you operate – whether it is seasonal, involves several different clients or whether you effectively work for one company but on a freelance basis at home. (The rules on such home workers have changed recently so it is worth checking the fine print or talking to someone knowledgeable).

An accountant or specialised tax advisor should also be able to offer advice on how to operate some of the aspects of your business. Should you own your car and charge out mileage to the company, or should the company buy it for you, for example.

Your advisor needs to be your business friend. If you already have a good working relationship with someone, lucky you. If not, ask around – other people in your field may have someone they can recommend. Maybe a member of the family can pass on a name. Whoever you choose, make sure you get on with them and can trust them implicitly. The wrong person could cost you dear.

Most will have an initial chat without charge and that should give you a feel of whether or not you are talking the same language. It might be worth checking to see if your accountant deals with any similar types of business or whether they are used to dealing with your level of profit (there is no use talking to a corporate man when you are dealing in hundreds and thousands, not hundreds of thousands).

One myth is that the taxman is an ogre out to get you at any cost – not true. True, they will come down hard on any offenders but if you are genuine, they will be as helpful as they can.

If you need help and do not have an accountant, do not be afraid to ask. Officially the tax office says returns have to be back in during September to qualify for assistance but if you have a simple question, phone up and ask.

Generally most tax officers would rather sort something out over the phone in a few minutes than spend days doing needless paperwork.

Dealing with tax

If you are setting up on your own, or even with a partner, it is easy to think that the fastest and easiest way to get the business going is to set out on the self-employed route. That is probably true in the early days. But even if you are only two individuals at the beginning, if you have any ambitions to hire staff it is worth setting up a PAYE system – or pay as you earn tax system – as soon as possible.

“If you start self employed and then take someone on it is an absolute nightmare. You have to work out half the year as self employed and the other as PAYE. I would say just make the effort and go PAYE straight away,” advises Julian Hare, financial controller at IB Net.

This may seem like an unnecessary burden when it is two of you working from the spare bedroom, but it could save you a lot of hassle later on in the year. The simplest way to resolve this is to simply outsource it to a payroll bureau. These are relatively cheap and easy to access.

Typically this will involve an upfront fee to set up the service and a small additional charge every time a staff member is added. This means that you won’t build up any nasty debts to the government in unpaid tax or national insurance – and these are nasty debts as the government tends to get paid – but for a small sum you are also assured of being up to date on all the latest rates and legislation. And when you do get to the stage of hiring staff, they will expect to be paid on time each and every month. You may be building a business for the future, but no matter how much they believe in your business, your staff are here for the cheque at the end of the month. Investing in a payroll system early will help to ensure that your most precious asset – your staff – don’t walk when the payslips are late.

Another administrative hassle that you might ordinarily choose to avoid is VAT. Unless your business is over the threshold – which is currently £67,000– you don’t have to register for VAT.

You do have a choice. If the administration involved is too much for a small company, you don’t have to register until you hit the threshold. But even if your company hasn’t breached the threshold, it is worth considering.

In fact, if your company is buying people-based services, it is unlikely that there will be much of a VAT element that you could claw back. However, if you are buying in raw materials, VAT is likely to be included in the cost and you might be able to reclaim that 17.5%.

It really depends upon your individual circumstances.

Even without the carrot of lower costs, it is worth becoming comfortable with the concept as soon as you can. “It is far easier to do it from the outset. You get to build it up and understand it and you don’t have the problem of where the threshold is,” says IB Net’s Hare. “In general terms I would say do it from day one always. There is no reason not to do it. It is not something to be frightened of.

What is self-assessment?

If you are self-employed you will need to register with the HMRC. You will then have to pay income tax based on your profitable income from the previous year. You will also receive a Schedule D coding from the taxman which allows you to offset business expenses against tax.

You will pay tax in two lump sums on January 31 and July 31. Self-employed people pay tax on a current year basis.

Using the previous year as a guide, you pay a first instalment on January 31 and the second on July 31. If you earn more than the previous year, you will have to pay the excess on the following January 31.

So most people face a bigger tax bill each January – never good news just as the Christmas shopping bills come in. But your accountant should be able to tell you well in advance what this bill is likely to be and hopefully give you enough time to save.

If, in contrast, you are doing less work in the current year and expect your tax bill to be less than previously, you can appeal to the taxman to reduce the payments – as long as you do it before the January 31 deadline.

With the arrival of self-assessment, the taxman has toughened up the rules on payment. Non-payment or late payment can result in an instant £100 fine, with larger penalties and interest charges for the worst offenders.

There are also reports that late payment may trigger a full investigation by the tax office.

Even if you do pay the correct amount of tax, these investigations are something to be avoided purely because of the paperwork involved - and the accountant's bill that you may have to run up.

We, of course, do not just pay income tax:

National Insurance. Everyone, except the very lowest wage earners, has to pay National Insurance Contributions. As a self-employed person, you can pay a basic amount quarterly or monthly by direct debit (Class 2 contributions).

You will also have to pay a top-up amount, depending on your income, along with your tax bill (Class 4 contributions). These are worked out as a percentage of your annual profits between lower and upper limits, which are set each year in the Budget.

For the year 2001-2002 as a self-employed person, you would have generally had to pay a Class 4 rate of 7% on profits of between £4,535 to £29,900 (maximum £1776).

Car Benefits. If the company owns your car, you will also face taxation on the car benefits. These vary according to engine size, fuel type and business mileage annually.

Employee Benefits. If you work from home but operate as a company, you will also face tax on some employee benefits. Working from home, this list is most likely to include such benefits as a cheap loan from the company or relocation expenses if you move your office (and home).

Capital gains. This is something to watch out for if you use a part of your property solely for business use, e.g. a garage that becomes an office. When you sell the property, there could be a capital gain on that section of the sale which could be taxable. It depends on the level of profit for that element, how long it has been an asset etc.

Savings. Most savings accounts are taxed at source. There are a few exceptions which are usually established as the account is opened – if you are over 65 or if the account holder is a minor. But the tax office will still want to know about all these interest earnings, likewise with any profits made from share dealings. Again keep records of everything and remember to include it all on the tax return.

What you need to do

Being confronted with a tax return for the first time is an unsettling experience for many people - but it’s genuinely not as bad as it first seems. Accurate financial record keeping, a level head and a knowledge of what support and guidance is available to you along the way can take the sting out of the whole process.

Becoming self-employed

As soon as you become self-employed, you are legally obliged to notify the HMRC. This is easy - a quick call to the IR’s Helpline for the Newly Self-Employed on 0845 915 4515 will set the wheels in motion. If you fail to notify the HMRC within three calendar months of becoming self employed, beware, as you could face a penalty.

If you’re in any doubt as to the distinction between being employed and self-employed - and it many circumstances it isn’t always obvious - the IR publish a guide called ‘Employed or Self-Employed?’ (Ref IR56), which is available from their website at: or from your local tax office. ‘Thinking of working yourself?’ (REF PSE1) also provides clear introductory information and is well worth a read. This can be downloaded from the HMRC website.

Make sure you receive your self assessment form

Once you’ve registered as self-employed, you should (in theory) automatically receive a self assessment pack the following April - the beginning of the new tax-year. The HMRC wants to know what your taxable income is based on your trading activity within the perimeters of both the last and the current financial years. If you have any income to declare that falls outside of working directly as an employee (under the PAYE scheme), the onus is on you to contact the IR to request a Self Assessment pack.

The ‘core’ form is called an SA100 and the self-employed are also required to complete a supplement (SA103) where details about a business income and expenses are completed.

Again, if you haven’t received SA103 within your pack, you must notify the IR as soon as possible - it is your responsibility, not the taxman’s. The HMRC order line can be contacted on 08459 000 404 or alternatively, the SA100, SA103 supplement and accompanying explanatory notes can be downloaded from the HMRC website

Your taxable income is calculated by subtracting allowable business expenses from your business’ income. The accompanying notes to SA103 provide information to get you started but calling the IR directly with any questions that occur is a good idea. The IR Self-Assessment helpline can be contacted on 0845 9000 444.

In order to calculate your taxable income quickly and easily, it is imperative that you keep accurate financial records from day one of trading.

You will need to maintain a record of all payments and receipts alongside details of all goods purchased or sold. Additional documents, such as copies of invoices you have sent to your clients (and those sent to you by your suppliers) are also important, as are bank related records such as paying in books, cheque book stubs and bank statements.

‘Self Assessment - A general guide to keeping records’ (SABK4) is available from the HMRC by clicking here

Support and guidance

The HMRC want people to understand tax (it’s in their interest as much as anyone else’s) and to this end operate Business Support teams throughout the UK. The Business Support teams offer free local workshops aimed squarely at new and small businesses. A directory of these can be found at:

Employing an accountant or tax advisor to complete you tax return on your behalf is another option. Yes, this does cost money but if your financial records are in reasonable order, this needn’t be too expensive - and you’ll be free to allocate your time to other areas of your business.

Do be aware, however, that September to January are the busiest times for many accountants, and you can expect to pay a premium rate if you turn up with incomplete records (or a Sainsbury’s bag full of receipts and invoices) close to the 31 January deadline.

The Institute of Chartered Accountants of England and Wales publishes a directory of its members at www.icaewfirms.co.uk as does The Chartered Institute of Taxation at www.tax.org.uk

Once you’ve completed the form, don’t forget to sign it - this is the single most common reason why returns are returned. If you’re close to the deadline this innocent oversight could cost you £100 - a great shame after all your hard work

Last minute top tips

The HMRC provides plenty of advice on how to make filling in your self-assessment form as painless as possible, but chances are if you are reading this then you have already ignored most of it.

Over the past four years, ten per cent of self assessment forms have been handed in late, and the HMRC can impose fines of up to £60 a day along with an instant £100 penalty.

But fear not, if you are fast approaching the deadline there is still hope. With a bit of hard work and a few of our handy tips you might just make get it done on time..

Get on with it –Obvious really, but if you’re form is not handed in by the January 31 deadline you could face a fine of up to £100 and have to pay interest on the tax you owe.

Go online – if you return is straightforward then use the internet because the tax will be calculated automatically, and is a simple and, most importantly, secure process. However in order to do this you must have already registered, so forget about leaving it until 11pm and then quickly jump online.

Check the pages – make sure you have all the pages you need, if you require any extra call the order line on 0845 9000 404, if you’re too late download them from the HMRC’s website.

Get all the information – If you have not done this by now you really do have your work cut out. Hopefully you will have had the foresight to have kept everything safe for the occasion but if not get it together before you start. If you’ve changed careers during the tax year, make sure you have copies of your P60 and P45.

Get help – you do not have to do it all by yourself, use the HMRC’s website or give their tax advisers a ring. Alternatively, if you are really up against it you might need to hire an accountant but be prepared to fork out at least a few hundred pounds for their services.

Check the form – make sure you’ve answered all the questions correctly. Remember it’s better to send it in late than incomplete. Sign the form, take a photocopy and then hot foot it down to the post office.

Good Luck!

Tax allowances

One of the benefits to being self-employed is being allowed to claim back certain costs against tax.

Equipment. All home office equipment costs can be offset. This can include such items as building storage units in your home as well as regular stationery bills, postage costs etc.

Use of Home. You can charge a reasonable fee per week to run your business at home. This covers an element towards heating. lighting bills, water etc.

Travel. You can include the cost of travel to see clients or to complete work. If you are travelling overseas on business, you can include most of these costs. But watch out for extending a business trip for pleasure because the taxman will not allow you to offset leisure costs against tax.

Entertainment. Some of these costs are acceptable. If you are staying away on business and are more than 50 miles from home, the taxman will allow the cost of evening meals etc., but he is not going to accept every pub meal bought locally as a legitimate business expense.

Pensions. You can offset pensions against tax. The benefits depend on your age but basically amount to a minimum of 17.5% of your net income - accountants often advise putting spare profit into a pension scheme as a tax-efficient way of saving.

Tax Allowances. There are a series of basic tax allowances available to everyone. Your accountant will have a list and the information is also available from the tax office. Such benefits include a basic personal allowance, which increases over the age of 65. The married person's allowance, an allowance for maintenance payments for dependent children and mortgage interest relief are three allowances that have recently been axed so may apply to previous year's tax payments but will not be applicable in the future.

Maternity benefits. Many women set up an office from home as they start a family. As a self-employed person you are entitled to state maternity allowance for up to 18 weeks (you can take this break either before or after the baby is born or both) provided that you are not invoicing out in that period.

Remember that a long break from work will probably mean a drop in income for the overall year. Think about appealing to reduce your tax payments.

The golden rules

Keep organised

Do everything on time

Do not be afraid to ask for help