When starting up a small business for the first time, many people opt to retain their full-time job and get things moving on a part-time basis but what does this mean for their tax situation?
As an employee, you pay tax through Pay As You Earn (PAYE) and National Insurance Contributions (NIC) which are deducted from your pay by your employer. Your employer calculates the necessary PAYE and NIC for you and pays this to HMRC (HM Revenue & Customs) on your behalf.
If you decide to set up a part-time business whilst in employment, you must notify HMRC. You can do this through the HMRC website and you must do this as soon as you start trading or you could face a financial penalty!
The tax that you are required to pay through self employment is dealt with separately to employment earnings. At the end of the tax year in which you commenced trading you must complete a Tax Return including a Self Employment section. Profits for the period up to 5 April after you started (and subsequent annual accounting periods) will be subject to Income Tax and National Insurance Contributions.
Self employed people pay different types of National Insurance contributions. As a self-employed person you will pay the Class 2 contribution, which is currently £2.95 a week (2018/2019). If your profits are below the threshold for the ‘small earnings exception’ you do not have to pay Class 2 National Insurance. However, you may wish to pay Class 2 anyway, in order to preserve your pension entitlement and certain other State Benefits. In addition, if your taxable profits are above £8,424 (2018/2019) you will also pay Class 4 National Insurance contributions. These in effect are an addition to your tax bill. You pay them together with your income tax to HMRC each year as part of your tax return.
Self employed payments of Tax and Class 4 National Insurance Contributions are required twice yearly – by 31 January and 31 July. You should remember to set aside a percentage of your business income to pay for the tax and NIC liability. This is best done by transferring, say 20/25 per cent to a separate bank account.
You will need to refer to your contract of employment with your current employer in case you are subject to a Restrictive Covenant which would prevent you from setting up your business while continuing to work for your current employer.