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How much money should I set aside to pay my personal tax bill?

Once you’ve been working for yourself for a while and have started to make a bit of money, you might think to yourself ‘how much money should I set aside to pay my personal tax bill?’

This is a great mindset to be in if you already are! One of the most manageable ways to handle your tax bill is to put some money aside each month, so that you end up with a pot for this very purpose when that tax bill comes in.

Being self-employed often feast or famine. You’re run off your feet, then the next minute you’re drumming your fingers on the table while you watch tumbleweed drifting past your window.

In a busy year, you might be tempted to pay yourself a bit more or take a lump of money from the business to reward yourself for all your hard work.

But if you haven’t put any of that money aside for tax, you might find that that BIG old tax bill from your feast year hits in a quiet spell.

Trying to pay off that high tax bill when you’re bringing in even less than usual can put a massive strain on your cashflow, on your business, and on you.

So how much should I put aside for tax?

You’ll hear a lot of people saying you need to keep 30% of your earnings aside for tax. And if you break it down, you’ll see that this makes sense.

Basic rate tax is charged at 20%, and National Insurance at 9%. That means, if you’re saving 30% of your earnings, you’re reserving just a little over basic rate tax plus National Insurance.

And when you factor in adjustments for your personal allowance and your expenses, you should come out just about right. You may even find you’ve saved a little bit too much, but that will be very welcome if you’re hit by a Payment on Account request from HMRC (when you pay six months of the following year upfront).

And ifyou’re not asked for Payment on Account, it’s time to put it towards a holiday! Or invest it sensibly in the business. Either way, it’s put to good use.

But…saving 30% for tax doesn’t make sense for every business

There are three scenarios where saving 30% for tax just doesn’t work:

Saving for tax when your income isn’t all that high

Saving 30% only makes sense once you reach a certain threshold, and there are plenty of businesses who don’t meet that threshold. Perhaps you’re still in the start-up phase and haven’t built up your business yet.

Maybe you freelance part-time to fit around the kids, rather than full-time. Or you might have taken a chunk of time off for maternity leave, paternity leave, travelling… you get the idea.

If you know you’re likely to earn less than £13,000, you should find that setting aside 10-15% of your earnings to cover your tax bill is more than enough. And any extra will help if you’re landed with an unexpected Payment on Account bill from HMRC.

Dealing with tax on your freelance earnings when you have additional income from elsewhere

Calculating how much to save for tax if your business has quite a few purchases and expenses.

If your freelance business provides a service, like graphic design or copywriting, you will have some expenses, but overall, you’ll take home a large part of what you charge your clients.

But that’s not the case for online shops and businesses which rely on buying large numbers of supplies to make their products or deliver their services.

Let’s say that you sell an item of jewellery or a piece of furniture for £100, and it cost you £50 in materials to make it. If you put aside 30% of your earnings, that’s £33 of that £100 straight into your tax pot.

Take out another £50 to cover the materials, and you’re left with just £17 to pay the rest of your business costs (rent, insurance, travel, bills, fees for PayPal, Etsy, Not-On-The-Highstreet…) and you have to try to live off some of that £17 as well. That’s not much when you started with £100.

The thing is, the costs of your materials count as deductible expenses. That means you’d only need to save 30% of what you’ve earned after taking off the expenses.

If you use accounting software, you can work this 30% out by looking at your net profit after expenses and saving 30% of that figure.

If you’re not doing regular bookkeeping, it’s likely you’ll still know how much it costs you to make each item, so you can work out how much is left after expenses and set aside 30% of that.

Saving about 30% for tax is right for lots of people, but not for everyone. To discuss this further and to get help with your bookkeeping and taxes, contact us here at The Hollies!