One of the main appeals of self-employment is having a lot more control over your work-life balance. On the other hand, that flexibility can often blur the lines between the two, especially if you work from home.
It will vary from person to person, but it’s important to know how to keep one separate from the other, especially in the way you manage your money. Whether it be for tax reasons, or regarding your credit score, It is important to define where your personal finance ends and your business finance begins.
In this short piece I will outline a few aspects of that transition with an accent on the financial aspect of self-employment, and provide links to helpful sources in order to get you started.
If you’re considering a complete transition to self-employment, one of the first things to consider is whether you should register as a sole trader or a limited company. Both options offer their respective advantages and disadvantages, and those have to be considered in relation to your personal ambitions, and to scale at which you’d like to grow.
Registering as a limited company might earn you more credibility when trying to work with large companies, and it can reduce your personal liability by having the company take on the risk associated with your business.
A sole proprietorship remains the first choice for many, with those entities making up 60% of small businesses in the UK. While you might not have access to work with big companies as a sole trader, you will not have to deal with as much paperwork and regulation than you would have to as a limited company, and you won’t be held to the same standards of transparency.
While it is not a legal requirement to do so, many opt to have a separate business bank account as a sole trader, which can help them make their annual accounts and tax return less complex.
Keep in mind there’s no straightforward answer to this question, and the decision you make should be very dependent on the type of business you are conducting, and to what scale you wish to take it in the future. The good news is that you can start off as a sole trader and eventually transition to a limited company if your circumstances change.
As mentioned in the previous section, there are different tax implications to being self-employed than being in employment with a separate company. And even while being completely self-employed, your tax payments and assessments will vary based on your status as either a sole trader or a limited company. In either case, the first thing to do is to notify HMRC of your self-employment and register as such before the 5th of October after the end of the tax year when you made the switch.
As a limited company, you will obtain a certificate of incorporation from Companies House and pay corporation tax, which currently stands at 19% of all profits earned by the company; you personally will also have to pay an income tax at a special dividend rate on any profits you pay to yourself from the company. There are a few different ways of structuring your income if you work through a limited company. That is one of the reasons some people favour the structure but inevitably that flexibility can bring additional complexity and consequently cost.
As a sole trader, your tax will apply to all profits that you generate as your own income above your personal allowance, which is currently at £12,500 a year.
In both cases, you will have to submit a tax self-assessment form, since there won’t be an employer to issue a PAYE payslip showing your various contributions. If you register a company, you will also be required to submit a tax return for the company. In some instances, it may be worth registering under an umbrella company which will take care of that paperwork for you, and cover many administrative duties such as invoicing and annual accounts for a fee while you still remain self-employed.
In certain industries, it can be difficult to draw a visible line in the sand between your professional and private life, especially if you transition to working for yourself. Some are passionate enough about their work that they see no need for this distinction, but it is strongly advised to mark that separation, at least from a financial perspective.
Setting yourself up as a limited company might be more advantageous in keeping that separation, since the company you register under assumes the legal risk associated with your business activity, and protects you from any losses your company might suffer. Although you, as a Director of that company, have legal responsibilities to that company. Limited companies are required to have a dedicated business bank account for all business transactions, but sole traders are not under the same obligation.
As a sole trader, you will be under no such requirement, and you can conduct business through your personal bank account. Since you will still be required to declare all business transactions to HMRC in your annual accounts, many choose to open a dedicated sole trader business bank account to help with accounting.
This advice could also be extended to expenses and monthly income. As a company, you can make a clearer distinction between your work and personal life by paying yourself a fixed salary as your income, and getting a business credit card for all business-related expenses, keeping them from encroaching on your personal ones. Whilst you cannot pay yourself a salary as a sole trader, withdrawing a monthly amount from your business account as an equivalent can be a simple way of keeping the finances more distinct. This separation will also help you in creating an accurate and realistic budget for your business, while not directly impacting your personal credit score. Its important to ensure that the monthly amount is affordable to the business and that you allow for any tax you will have to pay in your calculations.
If you work from home, a final piece of advice is to create that separation within your own household to foster the right mindset. This includes creating a clear work environment, and setting up a daily schedule to stick to a routine.
Every piece of advice detailed will likely have a separate dedicated article going into further detail, so if this has helped you want to get started, make sure to look at the additional resources I’ve added throughout this post.
