It is imperative to get your tax straight with the HMRC, and that is why we have written this article to give you a basic understanding of how the tax system when trading as a freelancer works.

Finding the right side gig to earn passive income can mean the difference between gaining or not. When it comes to taxation as a freelancer, it is only right that you are made aware of the HMRC thresholds as a sole trader. 

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Both estimates in the example below are on the prices and thresholds reported by the HMRC for fiscal year 2020/21.

The income you earn is taxed based on any amount above your personnel allowance; this will include employment income and sole trader profits. We'll talk a little later about the difference between earnings and profits.

It's necessary to note that you would have to pay the higher rate if your sole trader gains drive your overall earnings into a more top tax category.

• For example, for the 2020/21 tax year: revenue by an employer £35,000
• Earnings by sole trading (self-employment) £20,000
• Net benefit £55,000
• Personal allowance (£12,500)
• Gross taxable income £42,500
• Income tax charged at the lower rate (20%) £7,500
• Income tax charged at, the higher rate (40%) £2,000
• Additional income tax paid £9,500 for 2020/21, Scottish income tax levels are specific.

On earnings above the basic rate limit, you will pay income tax of 40 per cent until you reach the higher rate limit (which is £100,000 in the 2020/21 tax year). In this case, you pay a £ 5,000 income tax of 40 per cent.

You will disclose from your employer the tax already paid on your earnings when you prepare your annual self-assessment tax return (in this example £35,000 would have been taxed under PAYE arrangements). HMRC would then know that you have already paid tax on the part of your gross income. HMRC will figure out the rate of tax you spend on your self-employment income (£20,000 in this example) as you submit your self-evaluation. 

Your employer's NI you spend for your wages does not change so that it will be a little different from self-employed gains on your salary.

First, you will have to pay a flat rate of £3.05 per week if your self-employed profits exceed £6,475. This is known as National Class 2 Insurance.

Usually, you pay Class 1 NI through your employer via PAYE, but Class 2 is billed directly to HMRC with a direct debit that you can apply for online at Gov.uk. We have an article that contains all the information you need about how to register as a self-employed person.

You may also need to pay Class 4 National Insurance if you are doing well. For all self-employed earnings between £8,632 and £50,000, this is paid at 9 per cent and for all earnings higher than £50,000 at 2 per cent.

Class 4 Social Insurance premiums will be carried out on your self-assessment tax return just as your income tax is.

We can use the same figures from our previous example to show how it works: self-employment profits of £20,000 Class 2 National Insurance (52 weeks @ £3.05 a week) £158.60 Class 4 National Insurance (9 per cent on any profits between £9,500 & £50,000 – for example the gain is only £20,000 meaning 9 per cent £10,500) £945.00 Total National Insurance paid £11.103.60 Remember, you're going to pay £1.103.60

You can choose to operate as a single trader as a self-employed person or form your own limited company.

The fundamental difference is that there is no legal separation between you and your business if you're a sole trader. You are liable for all the business activities, including debts.

When you start a limited partnership, you create a distinct legal body, and you do not have any financial responsibilities. You will, however, have specific constitutional and statutory obligations to fulfil as the company's director. There are a variety of tax ramifications, too.

One of the critical advantages of self-employed status as a sole trader is that you can cover your company costs against your profits. You are paid on the earnings just for self-employed individuals.

There is a common scenario with limited partnerships – where only after allowable expenditures, Corporate tax is charged on business income. These can include wage and insurance payments, as well as specific travel and living expenses.

What exactly is treated as an acceptable cost and whether to justify is a problematic matter, let's not get into it here? Alternatively, check out our blog on freelance tax and side gigs, and take into account the "wholly and solely" rule (i.e. everything you say as a business expense must be strictly used for business.

HMRC advises that you tell them about your new company as soon as you start trading.

This is a mandatory obligation to file as a small company with HMRC if the earnings exceed more than £1,000 in a tax year as a self-employed sole trader.

If you're not full-time employment that will happen as soon as you get your first self-employed income. If you have received more than £1,000, you will have to file for Self Appraisal to let HMRC know, or face paying a fine by October 5th at the close of the tax year. Use this simple form on HMRC 's website to let them know.

However, if you are unable to receive more than £1,000, you don't need to file a self-assessment because HMRC has implemented the £1,000 trading bonus to remove the requirement to file a return in these conditions. 

Although it is generally not going to be a concern, it is understandable that you do not want your boss to know you are working on other projects. However, be vigilant, as your employment contract could prevent you from taking on external jobs, especially if there is a chance of conflict with your current employer.

Your tax issues are entirely private, and if you do file as a self-employed, HMRC does not notify your boss. Stay mindful, though, that the records are readily accessible at Companies House if you form a limited partnership, and that the boss may find out about your business this way.

Naturally, we will never suggest you deceive your boss. However, without revealing it, it is possible to continue the work outside. Only be sure you're doing it at your own risk.

If you want to try a freelance marketplace to start your freelancing career check out Skillbox today!