Top tax tips for the newly self employed

With the recession causing redundancies, more of us are choosing to become self employed. But there are plenty of tax issues you'll need to consider.

With the recession claiming new victims every day redundancy is, becoming a fact of life. Indeed, official figures released this week have revealed that the number of unemployed people in the UK reached a whopping 2.4m in June, its highest level since 1995.

It is perhaps not surprising that a large number of people are turning to self-employment - either by simply working for themselves or actually starting up their own business.

So what are the pros and cons for those who decide to work for themselves - otherwise known as 'self-employed sole traders'?

Pros and Cons

Being self-employed has its benefits and drawbacks of course.

You can decide upon your own hours, work to self-set deadlines and if you're based at home, you'll avoid the morning and evening rush hours (not to mention the travel costs). Plus there's no need to keep updating your office wear as jeans and t-shirt will suffice.

But on the downside you need to be organised, able to work by yourself and will undoubtedly miss the camaraderie of a workplace environment - not to mention the benefits being an employee brings. If you go on holiday or are sick you won't get paid.

Plus rather than simply receiving a payslip each month you'll need to take responsibility for paying your own taxes. Eek!

So here are a few tips for anyone thinking about becoming self employed.

Register immediately.

Although you may think you have all the time in the world, it is vital that you register with the HMRC as a self employed person as soon as possible. You can either fill in the online form or call the 'Self-employed helpline' on 0845 945 4515.

Just don't leave it too long - if you don't register within the first three months you'll have to pay a £100 fine. Ouch.

National Insurance - Class 2

Next up, you need to think about keeping up with your Class 2 National Insurance (NICS) contributions.

Class 2 NICS is set at a flat rate for everyone (currently £2.40/week) and you can either pay quarterly, or monthly by direct debit.

Some people are exempt (such as those receiving some benefits, or earning below the small earnings threshold), so it's worth checking.

But it's well worth paying as Class 2 NICS give entitlement to a range of benefits including the basic state pension, maternity allowance, incapacity benefit and bereavement benefits.

National Insurance - Class 4

But that's not the end of National Insurance. After Class 2 NICS comes its big brother Class 4 NICS.

Now, not everyone has to pay Class 4 NICS, it all depends on how much you earn. Self-employed people currently pay 8% on taxable profits between £5,715 and £43,875 and 1% on profits above £43,875.

So not only do you have to pay Class 2 contributions, if your profits are within this threshold you'll have to pay Class 4 NICS too. Class 4 NICS are payable twice a year so you'll need to consider setting money aside each month for this.

Extras

On top of NICS considerations you will of course need to set aside some money for your tax bill, which for lower rate tax payers means 20% of your earnings. The best place to stash this is in a best buy savings account or Cash ISA.

By systematically putting this proportion of your earnings away you'll be safe in the knowledge that when the time comes that you'll be able to cover what you owe. Plus you'll earn a bit of interest for yourself, to boot.

Then there's the whole expenses minefield.

If you need to use broadband, the phone and you work from home a proportion of your bills will be tax deductible. Various other expensese are also tax deductible, so you may need to save travel tickets, taxi fares, travel cards, bus tickets, petrol slips and even parking receipts for your tax return.

However, to make things easier sole traders can get away with simply scanning their receipts and keeping electronic copies. But do keep a working diary (this can be electronic), listing what was spent when to help you keep track.

Retirement

Finally, one aspect of being self-employed that many people forget about is their retirement.

As an employee you probably had access to a pension that your employer contributed to too, there are no such luxuries in the self-employed world - so you'll have to decide what to do for yourself.

Pension forecast

The first thing I would recommend is to get yourself a Pension forecast and see how much it reckons you'll get, upon retirement. It's very easy and can be done instantly, online.

Slightly unfairly, self-employed people are not allowed to claim the Second State Pension (S2P) so the basic pension is all you have.

If your forecast has shocked you I'm not surprised. Let's face it, the State pension may just about cover the cost of a few cans of beans by the time we come to retire.

So what will you do to make up the shortfall? Well, you can work for longer (fancy stacking shelves at 83 anyone?). Or you could start stashing some money away now.

Stakeholder pension

First option is of course a low-cost stakeholder pension - every £80 you save is automatically boosted to £100 by the government. And when you retire, 25% of this pot can be taken as a cash-free lump sum.

ISAs

But if pensions fill you with horror, you could always look at alternative savings vehicles such as ISAs instead. The amount you can stash away is much less, but the interest earned isn't taxed and the money is yours to do with as you wish (plus you won't have to buy an annuity!).

Whichever method you choose, do start saving somewhere as with the miracle of compounding you'll hopefully make your retirement a more comfortable one.

Finally, if you are concerned about the tax implications of becoming self employed I thoroughly recommend booking yourself onto one of HMRC's tax courses - they're free and can answer all your questions!

More: My top tax return tips | Homeworking is cheap