Early retirement, diminishing pension, low savings rates, investments faltering – there are many reasons why people in their 50s and 60s may want to earn some extra money. And what better way than starting your own business? It can be as simple as buying and selling things on the internet through eBay or Amazon. Or maybe you are an artist, a musician, a writer. Perhaps you can make things, or mend them – or you have the skills from work or life to become what is often grandly called a consultant. Age is no barrier. Grey hair and the lines of experience, which can be such a disadvantage in the world of employment, give a self-employed person a helpful gravitas.

Self-employed
First, you have to decide if you are self-employed at all. If you just empty the contents of your attic and sell them at a car boot sale, you are not self-employed. Nor is an artist who paints for fun but sells the odd picture. There is no minimum amount of earnings that mean you have become self-employed – what counts is your intention to make a profit. If you are buying things specifically to sell, if you buy things and sell them within a short time, or if you borrow money from the bank to buy them, that all argues in favour of your being self-employed. You can get advice from your local Inland Revenue Enquiry Office.

Once you are self-employed you have to register with the Inland Revenue. After the first month of self-employment you have just three months to register or face an automatic £100 penalty. And if you have still not registered by 6 October following the end of the tax year when you start up, further penalties may be due.

The easiest way to register is by calling the Inland Revenue’s Newly Self-employed Helpline on 08459 15 45 15. They will need your personal details including your National Insurance number and a tax reference number – you can find both on your last P60 or P45 from work. They will also ask you for the name of your business – you can always change that later. The important thing is to get registered.

Registering brings obligations to pay tax as self-employed and, if you are under pension age, to pay National Insurance. Self-employed people pay two sorts of National Insurance contributions.

Class 2 cost £2.05 a week (from April – all figures relate to the 2004/05 tax year) and keep your record up for earnings your basic state retirement pension as well as entitlement to Incapacity Benefit if you become too ill to work – though the test for self-employed people is pretty tough. You can avoid Class 2 contributions if your profit from the business is expected to be less than £4215in the tax year. But you have to register for what is called ‘small earnings exception’. You do that with the form at the back of leaflet CA02 Self-employed people with small earnings. However, as Class 2 contributions cost little more than £100 a year they are the cheapest way to keep up your National Insurance record. So if you can afford to pay them it may be worth doing so even if you expect to fall below the limit.

Class 4 contributions have to be paid if your profits in 2004/05 are more than £4745. You pay 8 per cent of the profits between that amount and £31,720 and 1% of your profits above that amount. Class 4 contributions are paid with your tax through self-assessment – they do not bring with them any rights or entitlement.

The good news is that you do not have to pay Class 2 contributions once you reach pension age – 60 for a woman, 65 for a man. You have to pay class 4 in the tax year you reach pension but not after that.

Profits
Any profits from self-employment are added to your other income and taxed. So if you have a pension – including a state pension – you will probably end up being taxed on most of what you earn from working for yourself.

You are taxed on your profits – which is the money you take in minus any costs of things you buy for the business and all the expenses incurred in running it. So every time you spend anything that on the business – from a bus ticket into town to buying a computer – keep the receipt and file it in a safe place. Every pound you legitimately spend on your business is a pound less on which you pay tax and National Insurance.

A good discipline is to work out your takings and expenses once a month – write them in an accounts book or use a computer spreadsheet – but remember to keep a back up on the computer and a print-out in a file. Keeping the books regularly will help you see how your business is doing and will speed things up when you fill in your tax return at the end of the year.

Home costs
Most self-employed people begin by working from home. You can charge some of the costs of running your home to the business. The most common of course is the telephone. There is no need to write down every call that is business. Get an itemised bill for three months and work out what proportion of the call charges are business and charge that proportion of your total bill – including rental – as an expense. Put a note in your accounts book to explain it and review it from time to time. You can do a similar calculation for the use of your car, noting your business and personal mileage over a month or two. You can charge that proportion of the total costs of the car to the business. Apart from fuel remember to include car tax, servicing, repairs, and the cost of any interest on a loan to buy the car – but not the capital cost of the car which is dealt with separately.

You can also claim a proportion of the cost of heating and lighting the room you use as your office as well as things like water. If that is one room out of four then you count a quarter of the costs as a business expense. When you work this out, only count the main rooms in the house, excluding the kitchen and bathroom. You cannot charge part of your council tax or your mortgage.

If your office is used entirely for the business then that part of the house may be liable for Capital Gains Tax when you sell your home. You can avoid that by making sure it has an alternative use as well. Perhaps keep it as a guest bed room or make sure the computer is used to play games or for personal email.

Items of equipment which will last for some time cannot be taken off your profit in the year you buy them. You take off 40 per cent of the cost in the year you bought it and then a quarter of what remains in each succeeding year. With a car the first year percentage is 25 per cent. And with computer equipment and some mobile phones it is 100 per cent. That concession is due to stop at the end of March, but may be extended in April’s Budget.

Once you have deducted your business expenses from the business income, the rest is your profit and forms part of your taxable income.

Self-assessment
Once you are registered as self-employed you will be sent a self-assessment tax return, including the self-employed pages, in April after you register. You must fill it in and return it by 31 January the following year – or get an automatic £100 penalty, though it is reduced if you owe less than £100 tax.

Paying tax can come as a shock. The golden rule of self-employment is to set aside a proportion of the business turnover in a separate savings account ready to meet your tax bill. Depending on your turnover and expenses you should put aside at least a quarter of every penny you are paid. If you think you may pay higher rate tax, then you should save more than that. Put it in a high interest account so that the money put by for your tax is itself earning money.

More tax
If you work from home there is usually no problem about calling yourself ‘self-employed’ rather than an ‘employee’. However, if you go to your clients’ premises and work there as an employee would, you may be considered a ‘contractor’ and have to pay tax and National Insurance through PAYE on your own self-employed earnings. This rule, usually called IR35, is the bane of many a consultant, particularly in computer work.

There is another tax you have to be aware of – Value Added Tax. If your turnover is more than £56,000 a year you have to register for VAT and charge VAT on any invoice you write. However, there is a special scheme if you are in any sort of second-hand trade and some items such as books do not attract VAT. It can get complicated but there are ways to make it simpler for small businesses – including a new flat-rate scheme where you pay a proportion of turnover as VAT. You can get information and help from the Customs & Excise National Advice Service on 0845 010 9000.

Further information
Tax and National Insurance: Inland Revenue Thinking of working for yourself P/SE/1 and The No-Nonsense Guide to Government Rules & Regulations for Setting Up in Business. You can get a copy by calling 0845 600 9 006.

IR35: Professional Contractors Group 0845 125 98 99

VAT: HM Customs & Excise 

March 2004

e-mail Paul Lewis on paul@paullewis.co.uk