Contracting - How much to set aside for tax?

Contractor's Question: I've just started out as a freelance consultant and I've looked through all the relevant guides, but am still unsure what percentage of my earnings I need to save for my incoming tax bill. I understand tax is applicable on anything over £6,495 (or close to that amount) and anything I use from the business gets taxed.

But I would like to plan for the 'worst case scenario' in terms of the tax due, as a percentage, of the money I earn. I then need to know the best way to lay out a spreadsheet to keep track of everything. I am a sole trader and not bothering with VAT for the first year.

Expert's Answer: It's a good idea to think about and start putting aside regular monies for your tax liabilities. As a sole trader you will be taxed on all profits from your business as if it were earned income. A general rule of thumb would be to set aside 25 per cent of your business income over the year, should it amount to less than £43,874.

However, should the profits exceed £43 875, you will become a higher-rate tax payer and may need to find extra funds. Bear in mind that this is not an exact science, as many factors need to be taken into account when completing your self-assessment tax return each year.

A simple spreadsheet showing one column for income and one column for expenditure will be sufficient for some businesses, whilst others may be more complex. Whatever the size of your business, the main thing is to aim to reconcile your income and expenses on a monthly basis and not wait and try to complete everything in a rush before the filing deadline set by HM Revenue & Customs. There are various websites and products which can provide readymade solutions for bookkeeping.

Lastly, you mention that you are not going to bother with VAT. Keep in mind that if you expect your turnover to reach or exceed £70,000 per annum, you are legally required to register for VAT. Even if you do not expect your turnover to reach this registration threshold, it may still be worth your while registering for VAT, and you should discuss this with a professional advisor to establish the potential advantages.

The expert was Alasdair McGill, managing director of Freelance World, a tax and accountancy specialist.

Monday 12th Jul 2010
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