Becoming Self-employed – Understanding Taxes
Tax for the sole trader
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Being self-employed is a great freedom, but it has its snags. Being more in control of your earnings means having to deal with your own taxes and saying goodbye to the cushy luxury of having it all automatically calculated for you. Failure to pay taxes can have nasty implications. If you’re thinking of starting your own business or going freelance and you’ve been mindfully ignorant of taxes until now, here is a quick guide to help you better understand the system.
Instead of being deducted from you weekly or monthly wage, your tax will now all be paid annually. As a result, your tax comes out as a much larger chunk. The best way to deal with this is to regularly pay money into a savings account that will be used to pay your tax return.
You’ll need to keep onto all receipts and statements so that you have a clear idea of how much income you’re getting and how much tax you need to pay. This will also help guide you as to what to put on expenses.
Expenses are payments that you have made related to your business than can deducted from your annual tax return. These can include the rent of any office, the cost of any equipment such as computers and a work phone, any repairs to these items you may need to make, any materials needed for your business and your vehicle (if it mainly used for business).
Knowing what to put on expenses can get complicated. For example, those working from home can claim a percentage of their rent/mortgage on expenses as ‘office space’, however the room you work in must be used solely as an office to get the full deduction. There is a lot of dependable IRS help out there for people who need help calculating their expenses.
Insurance schemes & extra taxes
Whilst not mandatory, many self-employed workers can forget to keep on top of insurance schemes that were previously provided by their employer. In the US, such schemes includes pensions and health insurance. When going solo, this becomes self-employment tax, covering social security and Medicare. In the UK, healthcare is free, but there is still National Insurance, which will help you be eligible for pensions bonuses. Putting some money aside for these schemes can help you receive the benefits.
Extra taxes can sometimes occur as the result of self-employment. These usually arise when taking on employees and can include social security taxes, workers compensation, leave benefits, unemployment insurance and disability insurance. In the UK, employers must pay a compulsory liability insurance, whilst other forms of insurance are optional. This can make taking on staff costly, so you must be certain you are making enough income yourself before taking this step.
Combined with the other bills and insurances of modern life, keeping on top of payments can become confusing. However, it must be remembered that being self-employed gives you more of a freedom over how much you can earn as opposed to being an employee. Making the most of expenses can also deduct costs, so whilst it may seem more expensive to begin with, you’ll soon find yourself earning more so long as you’re sensible!