Self Employment and Small Business: Saving for Tax in the First Year

Gibraltar £5 Note

Whether making the transition to self employment full time or just running a small business as a sideline, it’s essential to put aside enough money to cover the tax bill at the end of the year.  However, due to the system of making “payments on account” it may mean that you need to save more in the first year than you actually think.

Tax in the First Year of Operation

Although you will need to register with HMRC for taxation reasons as soon as possible after commencing operations, the great news is that with the exception of class 2 NICs you won’t be sent any further bills until after filling your first tax return at the end of the financial year (April).  However, most engaging in self employment will set aside a percentage of their income to cover the tax bill when it arrives.  In essence this should be quite simple, just put aside the relevant percentages for tax, national insurance and any extras such as student loans right?

Unfortunately in the first year of operations it’s not quite this simple due to the fact that your first tax bill will include a balancing payment and two payments on account which will mean that you effectively need twice as much as you might have thought.

Your First Tax Bill

In this case let’s assume the business filed its first tax return and the owner correctly estimated based upon the relevant tax bands a tax liability of £5k.  When the tax bill comes there will be three payments to be made as follow:

Balancing Payment £5k – In the first year this considers that you have no credit with HMRC and therefore pay the entire sum due for the previous year.  This is due by the January 31^st deadline.

Payments on Account £5K – In addition to the balancing payment, HMRC also requires you to make a provision for taxation for the coming year, these are split down into two payments on account (£2.5k each in this case) due in January and July and are based upon the total amount of tax due in the previous year according to actual profits.

As such, due to the fact that at the end of year one you have to pay both your outstanding tax and make a provision for the coming year, the effect is that your tax bill may be twice what you were expecting.

So, while it may be great that you don’t have to part with your money straight away as with the PAYE system, the first tax bill may come as a shock and the moral of the story is to save as much as possible in the first year.  However, when the bill does finally come, don’t panic and remember that you have until the January and July deadlines respectively to get the money over the HMRC.

Useful Links:

HMRC Deadlines

HMRC Rates