How the self-employed should approach tax, the five most common mistakes they make and how to avoid them easily
For the self-employed, tax can be a minefield. Not having an employer or financial department to handle it on your behalf can be intimidating because doing it wrong risks an investigation by HMRC and a large fine.
The PAYE system is effective because it (largely) removes room for error and calculates everything automatically based on earnings, taking what is owed from an employee’s pay before they receive it. But for the self-employed, it isn’t so simple. Instead, they must keep track of everything themselves throughout the year and submit a tax return. Sounds simple enough, but anyone who has lived through it can probably agree that it can be nothing short of a nightmare.
To help with the process, here are five of the biggest mistakes I see the self-employed make when tackling tax and some advice on how to avoid them.
1. Not seeking professional advice
Tax is complicated and not everyone’s area of expertise. And that’s OK. So, the self-employed should be honest with themselves on whether or not they have the time and capacity to dedicate to regular and detailed bookkeeping.
If the answer is no, then it’s probably best to seek outsourced, professional help. Working with an accountant will reduce the potential for errors and ensure the books remain fully compliant with legislation, including:
• Allowable expenses
• National Insurance Contributions
• Tax returns and liabilities
They can also advise on tax allowances and relief, which are often complex pieces of legislation but could save thousands on a tax bill.
Accountants will also have an expert grasp on deadlines, so there won’t be a mad rush to complete everything which can result in simple mistakes and costly fines.
2. Not keeping accurate records
Without accurate records, it’s easy to lose track and end up losing money. It is one of the key vulnerabilities for the self-employed, especially during peak times. This is because it’s easy to leave admin for another day when you’re busy with orders to fill or projects to complete. But how do you know you’ve been paid for that invoice from three months ago if you haven’t kept a record of it? This can lead to a nightmare game of connect the dots and make filing an accurate tax return almost impossible.
Every transaction, incoming and outgoing, should be recorded. Ideally, in real-time. This is the only way to maintain accurate records and have a true gauge on finances. When claiming tax deductions for allowable expenses, HMRC requires evidence of receipts for up to six years. Poor records won’t stand up and can result in disputes with HMRC. If you are likely to lose receipts, taking a picture and emailing it to yourself is one quick way to prevent this.
There are several different types of accounting software to help record income and expenditure, but they are not all built the same and some are better than others. It’s best to carry out a careful analysis before committing to one to ensure it’s fit for purpose.
If you’re unsure, asking for professional advice on the right package for individual circumstances is a smart idea. This is particularly important as HMRC now requires digital records.
3. Ignoring cash flow
A positive cash flow is essential for maintaining a healthy business. All too often I see self-employed people operating from one day to the next, which is neither efficient nor effective. Promptly invoicing customers is essential. By doing so, the self-employed are more likely to receive payment in a timely manner, allowing them to settle liabilities with their own suppliers before there is risk of late fees. This will also keep you in their good books.
Not invoicing right away results in a delay later down the line as customers take longer to pay, resulting in cash flow issues which can impact personal finances as well as business ones. The most common reason why businesses fail is because they run out of cash. Don’t let this be you.
There are tools that come with an accounting system which can help streamline this process and ensure efficiency for a healthy flow of cash.
4. Failing to budget for tax
Preparing and filing the paperwork for a tax return is one thing. But having the money to pay it, is another. Budget needs to be set aside regularly (preferably monthly) to pay for the liability otherwise the end of January will arrive and there won’t be any funds to pay HMRC. Whilst the deadline for filing a tax return is 31 January, which is particularly mean for the self-employed as it’s only a matter of weeks after Christmas, it helps to start preparing shortly after the end of the tax year on 5 April. This leaves plenty of time in the year to set money aside.
5. Misuse of cash
Payments made or received using a card or bank transfer means there is a digital record of the transaction date, amount, and recipient’s name, which is valuable information for business accounts. Making or receiving payments in cash, however, means the information needs to be manually recorded later.
It’s easy to forget a transaction or input the information with errors. To prevent this, it’s best to avoid using cash – especially for allowable expenses. This avoids the risk of missing transactions when putting accounts together and having to pay unnecessary tax liabilities.
Avoiding these five mistakes will ensure a smooth tax year. But, if you’re still unsure, the Wellers’ website has more advice on tax for the self-employed.
The author
Ercan Demiralay is a partner at Wellers, one of the UK’s leading accountancy firms.
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