Understanding personal taxes can be very tricky, but once you understand how they work, when different taxes apply to you and how to manage them as a contractor or freelancer, it will inevitably make your work and financial life far easier to manage. Although specific tax arrangements and payments will vary from case to case and contractor to contractor, the main taxes to be aware of are:
- Income Tax
- National Insurance
- Universal Credit
These three taxes are the basic taxes that almost all workers will have to pay (although Universal Credit is unlikely to apply as you become more successful.) All personal taxes must be paid to Her Majesty’s Revenue and Customs (HMRC) on time and in full to avoid penalty charges and even legal action.
If you are employed by a contractor umbrella company, you will need to understand and be aware of these taxes but will not need to worry about the payments and time limits for each, as your umbrella company will take care of this.
Tax years run from April to April so you should always get your taxes in order prior to the end of each tax year.
Income Tax in the UK
Income Tax does exactly what it says on the tin, it is the tax that you will have to pay on your income. However, you will not have to pay Income Tax on all forms of income and there are thresholds to be aware of with regards to Income Tax which increases incrementally and as your earnings increase.
You will pay Income Tax on things like:
- The money you earn from your employment
- Any profits made if you are self-employed, working as a sole trader; this includes any services you sell through websites or apps.
- Certain state benefits
- Most pensions including state pensions, company and personal pensions as well as retirement annuities.
- Income from rent; this will not be the case if you are in a live-in landlord and get less than the ‘rent a room’ limit
- Any benefits from your job
- Income from a trust
- Interest on savings in your savings accounts
You will not have to pay Income Tax on:
- The first £1,000 of income on your earnings from self-employment – this is known as your trading allowance
- The first £1,000 of income from the property that you rent, unless you go through the Rent a Room Scheme
- Income from tax-exempt accounts. This could be individual savings accounts (ISAs) and National Savings Certificates
As of the 2018/19 tax year, the first £11,850 you earn as personal income is Income Tax free, so long as you are not earning more than £100,000 (at which point you start to lose your Personal Allowance.) The brackets for Income Tax are as follows:
- £11,850 – £46,350 taxed at 20%
- £46,351 – £150,000 taxed at 45%
- Over £150,000 taxed at 45%
This will vary depending on your specific tax arrangements and this should be discussed with your employer, umbrella company and HMRC as necessary.
UK National Insurance Contributions
You will be paying National Insurance Contributions to qualify for certain benefits in the UK, as well as a State Pension. You will pay National Insurance if you are 16 or over and either:
- You are an employee earning above £162 a week
- You are self-employed and making a profit of over £6,205 per year
Before you can start making National Insurance contributions, you will need a National Insurance number. The amount you are going to be paying does depend on how much you earn in a year and your employment status. The precise amount of National Insurance you pay varies depending on your income, expenses and tax arrangements.
You will pay your National Insurance alongside your tax, so your employer will simply deduct the amount you are paying off of your wages before you get paid. Providers of umbrella company services in the UK should account for this so you don’t have to. Your payslip should clearly reflect this by showing your contributions. If you are a director of a limited company, you may also be your own employee. Therefore, you will pay your National Insurance through the PAYE payroll.
Universal Credit is a benefit payment to help with your living costs. You may be eligible if you are out of work or if you are on low income. Whether you can claim Universal Credit, does depend on where you live and your personal circumstances. Universal Credit has been introduced to replace six benefits previously offered by the government. Universal Credit has replaced the following:
- Child Tax Credit
- Housing Benefit
- Income Support
- Income-based Job Seeker’s Allowance (JSA)
- Income-related Employment and Support Allowance (ESA)
- Working Tax Credit
If you currently receive any of the above benefits, you cannot claim Universal Credit at the same time.
Personal Allowances in the UK
Your Personal Allowance is the amount of income each person is entitled to receive tax free each year. The basic personal allowance in a tax year is £11,850. Everyone is entitled to this, including students. This is set to rise for the 2019/20 tax year to £12,500, meaning you will be able to earn more money before having to pay tax.
However, this can shift. For example, everyone whose income is over £100,000, the personal allowance is reduced by £1 for every £2 earned over the £100,000 level. A person whose income is over £123,000 won’t receive any tax-free income as their personal allowance will have been reduced to £0.
It depends on how you receive your income as to how your personal allowance will be applied. You may also find that you are entitled to more if you claim Marriage Allowance or Blind Person’s Allowance. Equally, you may receive less if you owe taxes from a previous tax year. If you are self-employed and have no other forms of income, you will get your Personal Allowance taken off of your profit before you work out how much income tax to pay.
If you are an employee with a salary, your employer will apply your Personal Allowance to your wages when it comes to them working out how much income tax they need to deduct from your wages. They will usually do this by the way of your tax code and through a payroll software. This also applies in the case of contractors and freelancers employed by UK umbrella companies and it is a fundamental part of an umbrella company’s function.