This is a complex question with no simple answer, as there are many factors that determine how much tax someone pays. Both employed and self-employed individuals need to pay income tax and National Insurance contributions, but the rates and allowances can differ.
Tax differences between employed and self-employed
Here are some of the key differences in how tax works for employed vs self-employed people:
- Employed people usually have tax and National Insurance deducted automatically from their salary via PAYE. Self-employed people need to calculate and pay their own tax and NI bills.
- Employed people don’t need to file a tax return unless they have additional untaxed income. Self-employed people must complete annual tax returns.
- Employed people have the benefit of the tax-free Personal Allowance (currently £12,570). This reduces the taxable income subject to basic rate tax. Self-employed people have to account for the Personal Allowance within their tax calculations.
- Employed people pay Class 1 National Insurance contributions. Rates are 12% of earnings between £9,880 and £50,270, then 2% above £50,270. Self-employed people pay lower Class 4 NICs – 9% of profits between £9,880 and £50,270, then 2% above £50,270.
- The self-employed can claim more expenses to offset against their earnings, reducing their taxable profit. Employees have fewer allowable expenses.
- The self-employed may need to register for VAT and can reclaim VAT on allowable business purchases.
Factors that affect individual tax bills
There are also several personal factors that can affect an individual’s overall tax liability, regardless of employment status:
- Earnings level – higher earners pay more tax due to the progressive nature of UK income tax. They quickly move into the higher 40% and 45% tax bands.
- Taxable benefits – some employed people receive taxable benefits from their employer, like a company car, medical insurance, etc. These are added to taxable income.
- Pension contributions – pension payments qualify for tax relief, helping reduce taxable income if sufficient contributions are made.
- Second jobs – income from additional employments or self-employed work can push someone into a higher tax band.
- Taxable investments – interest from savings accounts and income from stocks & shares outside of ISAs are subject to tax.
- Individual circumstances – such as child benefit tax charges, loan interest relief and charitable giving, which affect tax liability.
Tax examples for employed vs self-employed
To illustrate the differences, here are two example scenarios comparing the tax paid by a self-employed person versus an employee with the same gross earnings:
Example 1 – Employed basic rate taxpayer
- Gross salary: £27,500
- Taxable income after Personal Allowance: £14,930
- Pays 20% basic rate tax on £14,930 = £2,986
- Pays 12% Class 1 NICs on £18,620 of earnings = £2,234
- Total tax and NI bill = £5,220
- Effective tax rate as % of gross salary = 19%
Example 2 – Self-employed basic rate taxpayer
- Self-employed profits: £27,500
- Taxable profit after expenses and Personal Allowance: £14,930
- Pays 20% basic rate income tax on £14,930 profit = £2,986
- Pays 9% Class 4 NICs on £18,620 of profit = £1,676
- Total tax and NI bill = £4,662
- Effective tax rate as % of gross profit = 17%
For a basic rate taxpayer with the same gross income, the self-employed person pays less income tax and NICs in this example due to the lower Class 4 NICs rate.
Higher rate taxpayer examples
The tax savings for self-employed are less pronounced for higher earners who quickly move into the 40% tax band. For example:
Example 3 – Employed higher rate taxpayer
- Gross salary: £60,000
- Taxable income: £47,430
- Pays 20% tax on £37,700 = £7,540
- Pays 40% tax on £9,730 = £3,892
- Pays 2% NICs on £10,000 = £200
- Total tax and NI = £11,632
- Effective tax rate = 19.4%
Example 4 – Self-employed higher rate taxpayer
- Self-employed profits: £60,000
- Taxable profit: £47,430
- Pays 20% tax on £37,700 = £7,540
- Pays 40% tax on £9,730 = £3,892
- Pays 2% NICs on £10,000 = £200
- Total tax and NI = £11,632
- Effective tax rate = 19.4%
For higher earners, the total tax and NI liability works out the same in this case, whether employed or self-employed.
Conclusion
In summary, self-employed people can often pay lower income tax and NICs than employees with an equivalent income, primarily due to the lower NICs rates. However, the tax advantage reduces at higher incomes as taxpayers quickly move into higher tax bands.
To specifically answer the original question – employed people do not automatically pay more tax than self-employed. Depending on individual circumstances and income level, self-employed people can sometimes pay less overall tax than employees.
Determining exact tax liabilities for employed vs self-employed is complex. It requires comparing many factors like income tax rates, NICs, allowable expenses and deductions. Speaking with an accountant can help clarify the optimal structure based on your particular situation.
Frequently Asked Questions
Do the self-employed get taxed more than employees?
No, generally the self-employed do not get taxed more than employees. Self-employed people can often pay lower overall income tax and National Insurance contributions compared to employees with similar earnings. This is mainly due to the lower NICs rates charged on self-employed profits.
Do self-employed pay more National Insurance?
No, the self-employed typically pay lower National Insurance contributions than employees. Employees pay 12% Class 1 NICs on earnings between £9,880 and £50,270 per year. The self-employed pay 9% Class 4 NICs on profits in the same threshold, then 2% NICs above £50,270.
Who pays more tax, employed or self employed?
There is no simple answer – it depends on the individual’s income level and circumstances. At lower earnings, self-employed people can pay less total tax and NI than employees. But at higher incomes, the tax difference reduces. Higher earners quickly move into the 40-45% tax bands where employment status has less impact.
Do self-employed get better tax breaks?
Self-employed people can potentially claim more business expenses to offset against their earnings, reducing their taxable income. Employees receive fewer tax deductible expenses. The self-employed may also benefit from some specific tax reliefs for business costs like mileage, office space used at home, accountancy fees etc.
Is it better to be self-employed for taxes?
Being self-employed can be tax-advantageous, mainly due to the lower National Insurance contributions levied on self-employed profits. However, the additional admin burden and responsibilities of being self-employed need to be considered. An accountant can advise on the best structure based on your individual circumstances.
Tax Tips
Here are some tips to help minimise your tax bill, whether employed or self-employed:
- Claim all available tax reliefs and deductions you are eligible for
- Pay pension contributions to benefit from tax relief
- Use ISAs and other tax shelters for savings and investments
- Consider tax-free employee benefits like cycle schemes
- Claim expenses allowable against your employment or self-employment
- Be aware of taxable benefits provided by your employer
- Spread income evenly across tax years
- Incorporate as a limited company if self-employed for potential tax savings
An accountant can advise you on legitimate ways to structure your affairs tax-efficiently based on your particular circumstances.
Useful Resources
Here are some useful resources for more information on taxes for employed vs self-employed: