How to pay taxes as an independent contractor
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One of the most challenging things about becoming an independent contractor is understanding what taxes need to be paid and navigating when to pay them.
The UK has one of the highest numbers of independent contractors globally, with over two million people identifying themselves as independent contractors. Contractors pay taxes on company profits and personal income.
In this guide, you’ll learn
- How to register your business with HMRC
- Types of taxes you may need to pay
- Keeping track of your taxes and accounting
- How to submit your taxes
How to register as self-employed
The first step to paying your taxes is to tell HM Revenue and Customs about your business. How you register your business will directly impact how much you pay in tax and the liability your personal finances will face.
As a sole trader
This is a common method that lots of self-employed contractors choose to use. Being a sole trader means you run your business as an individual. This means your business assets and liabilities aren’t differentiated from your personal ones.
Being a sole trader is ideal for anyone who wants to start out simple before expanding with additional products and services. Use our guide to help you register as a sole trader.
Setting up a limited company
Setting up a limited company is a popular route for contractors with a long business history and a larger client base. However, it comes with more admin obligations for your financial reporting, which can be needlessly burdensome for some contractors, depending on their business size.
Sole trader or limited company? Find which one is best for you in this guide.
Taxes you may need to pay
Income tax
UK citizens are entitled to a tax-free personal allowance of £12,570. Once you earn beyond this, you will be subject to tax rates according to how much you earn. You will need to complete a Self Assessment Tax Return and pay any taxes owed on any income that you receive by 31 January after each tax year. Failure to meet the deadline will result in a fine.
National insurance
Self-employed individuals, like sole traders, pay Class 2 and 4 national insurance but at specific rates depending on their profits. If you’re a limited company director, you have different rules because you’re classed as an employee for tax purposes.
Learn more: how much National Insurance do you pay as self-employed?
Value Added Tax (VAT)
VAT is a tax that businesses (companies and sole traders) charge customers and pay to HMRC once they have an annual turnover of £85,000 or above.
Learn more: 7 things you need to know about VAT
Dividend tax
One of the most tax-efficient ways to make the most of your income is to draw your money from your dividends, i.e., shares in your company. This method of income filing is only available to company directors.
Learn more: is drawing money from dividends for you?
Corporation tax
Limited companies have to pay corporation tax on any profit they make directly from their business or from the sale of any assets they have. To pay this tax, you will need to file a Corporation Tax Return (CT6000) and pay any taxes owed nine months after the accounting period of the previous financial year.
Learn more: a complete guide to corporation tax
Capital gains tax
This tax affects sole traders and works similar to corporation tax. Capital gains tax is applied to the profit you make on the sale of business assets and is relative to your personal income. There are some exceptions, like cars and goods up to £6,000, and allowances depending on who you sell the assets to.
Learn more: capital gains tax tips to lower your bill
Keeping track of your taxes and accounting
Across your trading, you’ll need to keep track of your business’ income and expenditure. The exact extent of your admin will depend on whether you’ve chosen to operate as a sole trader or as a limited company.
In general, you’ll need to keep a record of receipts and invoices you send to clients and those your business receives. You may also need to keep records of your personal income, assets your business has and the equity and structure of your company.
How to submit tax
Independent contractors can pay their income taxes through HMRC’s Self Assessment system. Self-employed business owners earning over £10,000 will need to sign up for HMRC’s Making Tax Digital initiative for their income taxes by 6 April 2023 and follow the rules for future returns.
Similar schemes for VAT returns and corporation taxes are either currently live or are planned in the next few years. Therefore, businesses will have to find approved software solutions like Countingup for their future accounting and tax payments.
Save time on tax return admin
If you’re new to independent contracting work or running a limited company, figuring out your tax obligations can be confusing. Without a complete understanding of UK tax rates and where your income falls in relation to them, you could end up paying more than you need to, or with fines on top of what you owe.
The Countingup app is saving thousands of contractors across the UK hours of stressful admin. Countingup is the business current account and accounting software in one app. It automates time consuming financial admin so that you can focus on running your business. With instant invoicing, automatic expense categorisation and cash flow insights, you can confidently keep on top of your business finances every day.
You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple and straightforward!
Get the Countingup app to apply for your business current account in minutes. All you need is proof of ID and a selfie. Find out more here.
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