How freelancers and employees are taxed differently

As the UK’s employment figures and trends continue to adapt to the job market in the wake of Coronavirus, there is an increasing variety in the types of employment opportunities available. A study by Jooble shows that the number of freelance positions advertised in November 2021 increased by a whopping 82% compared to the prior month of October 2021 alone. In 2020, it was reported that a staggering 2.2 million people in the UK were working as freelancers which accounts for 49% of all those who are considered self-employed. If you’re looking for a new job opportunity, be sure to understand freelancers and employees are taxed differently first.

What is the difference between a freelancer and an employee?

A freelancer is someone who offers their services to other businesses. Some of the most common freelance services include graphic design, copywriting, virtual assistance, web development and bookkeeping. Freelancers are able to set their own fees for their services and can choose to work with as many businesses as they want to. They have much more control over the scope of their work and are able to dictate or agree a set number of hours or days they will work for the client. However, they are also solely responsible for the amount of work they have which can mean that earnings can be unstable. Not only that but there is no financial support when a freelancer wants to take a holiday or falls sick and is unable to work.

An employee on the other hand enters into an employment contract with an employer.  The agreement means that a specified role and responsibilities have been defined by the employer and is offered to the employee in exchange for a determined salary. Many other terms are dictated by the contract of employment such as the number of hours that the employee is required to work, and also often when they are to be worked, as well as where they are to be worked. Usually, employees are not allowed to take on additional work from other employers. However, employers are also under a legal obligation to provide certain benefits including statutory sick pay if the employee qualifies and a minimum of 28 annual leave days for full time workers.

Do freelancers pay more tax than employees?

Freelancers do not pay more tax than employees because they are subject to the same income tax rates. For the tax year 2023/24 the personal allowance is £12,570 which means that both freelancers and employees can earn up to this amount without having to pay any tax. Any amount over this threshold is then liable to income tax which is set at the basic rate of 20% until £50,270, the higher rate of 40% is on earnings between £50,271 and £125,140 and the additional rate of 45% on all earnings over £125,140.

However, freelancers who earn over £90,000 must become VAT registered. This means that you must not only pay VAT to HMRC, but you must also charge VAT on top of your fees for your services to all clients. In practice therefore, VAT payments and charges should balance out so that you neither profit nor suffer loss as a result of being VAT registered. Employees will never need to be VAT registered, no matter how much they earn through their salary.

Do freelancers pay less tax than employees?

In the same way that freelancers do not pay more tax than employees, they also do not pay less tax, again, because of being subject to the same income tax rates. However, it can be said that freelancers have more opportunities to reduce their tax than employees by claiming for allowable expenses. This is because in most situations, employees are provided with the necessary equipment by their employers to complete their job such as a computer or tools. However, if you are working as a freelancer, there is no one to supply this for you apart from yourself. If you make purchases in order to carry out your services such as office furniture or software, then you’ll be able to reduce your income tax liability by offsetting the cost of equipment against your earnings. If you were an employee and had to buy a train ticket to visit a client or buy coffees for a meeting with a client, you are likely to claim the cost of this back from your employer so you will not be out of pocket. However, it doesn’t reduce your income tax as it doesn’t affect your salary in any way.

How are freelancers and employees are taxed differently?

Freelancers and employees are taxed differently through two different tax systems. Employees are taxed through the PAYE or ‘Pay As You Earn’ system whereas freelancers are taxed through the self-assessment tax return system.

When an employee starts work with an employer, they are usually asked to complete a New Starter Checklist form. This enables the employer to gather all necessary information required to add the employee onto their payroll system. By being added onto the payroll, the employer is able to pay the employee their salary, but also take deductions from their earnings before they are paid including their income tax and Class 1 National Insurance contributions. This is paid directly to HMRC on the employee’s behalf. This is often referred to as being ‘taxed at source’. In this way, there is nothing the employee needs to do themselves to ensure they are paying their taxes. Employers should always ensure that they provide employees with a payslip each time they are paid which outlines what deductions have been made.

In comparison, freelancers must register as self-employed with HMRC to enter into the self-assessment tax return system. Anyone who is self-employed or receives income which is not taxed at source needs to complete a self-assessment tax return each year. It is your responsibility to ensure you have kept accurate records of your earnings in order to be able to complete the self-assessment tax return form by 31^st January each year. Not only that, but any taxes due to be paid must be paid in full by the deadline also, including Class 2 and Class 4 National Insurance contributions. Unlike being employed, if you are freelancing, you are wholly responsible for declaring and paying your tax.

How to pay tax if you’re employed and freelancing

Many people have more than one job, and it is not uncommon to be employed as well as self-employed. If this is the case for you then you simply follow the tax systems outlined above. There is nothing you need to do regarding paying tax from your employed income. Your employer will take care of this for you through their payroll system, however it is recommended that you check the correct tax code is being applied to you. You must still register as self-employed with HMRC and complete self-assessment tax returns to declare earnings you make as a freelancer. You will only need to pay tax from your freelancer earnings yourself by the tax deadline as tax from your employed earnings will have been paid throughout the year by your employer.

This article has been written in partnership with the team at Jooble. For help completing your self-assessment tax return as well as advice on how to reduce your income tax from your freelancer earnings, please get in touch for a consultation.