The fundamental reason numerous employees choose to take the solo ride via self-employment is that this business structure offers the freedom to be your own boss and earn more financial rewards based on your efforts, skills, and acumen. This guide provides a thorough comparison of PAYE and Self-Assessment for self-employed workers, outlining the key differences, advantages of each.
However, with several ups come many downs as well. To clarify, being self-employed means that you will also have to deal with business liabilities independently, such as setting up your business structure single-handedly and managing all financial and legal aspects of the business.
Likewise, when confronting tax obligations, self-employed individuals primarily have two primary methods: Pay As You Earn (PAYE) and self-assessment.
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PAYE and self-assessment: Understanding the difference between the two:
Let’s understand the difference between PAYE and self-assessment by discussing each separately:
What is PAYE?
Under the PAYE scheme, the employers first deduct income tax and National Insurance contributions (NICs) payments from the employees’ salaries. Next, employers distribute the post-deduction wages to the employees. Eventually, the employers send the deducted amounts to HMRC on behalf of the employees.
It is noteworthy that employers operate PAYE as a part of their payroll processing, which comprises the calculation and distribution of wages among employees.
The PAYE system ensures that employees pay their tax liabilities gradually throughout the year, avoiding the possibility of big tax payments.
Moving ahead, the main features features of PAYE include:
- Tax is deducted automatically from salaries or pensions.
- Employees receive a payslip with tax breakdowns.
- HMRC assigns a tax code which determines the amount of the deductible tax.
- By operating PAYE, employees are not required to file a self-assessment tax return unless they have additional income sources to report to HMRC for tax purposes.
What is self-assessment?
HMRC self-assessment is the income tax collection system used by self-employed individuals, freelancers, and business owners to calculate and report their income tax obligations to HMRC. Unlike PAYE (wherein the mandatory tax deductions are automatically made), self-employed workers are obliged to calculate and submit their own tax returns annually.
The prime features of self-assessment include:
- Tax is not deducted at source. Instead, individuals must set aside money to cover their tax liabilities.
- It is mandatory to report the taxable income and allowable expenses on an annual tax return.
- There are usually two deadlines for filing the self-assessment tax returns. For instance, self-employed individuals can pay the tax owed by midnight on 31 January 2025. Alternatively, HMRC also allows for a second payment deadline of 31 July. It is only eligible for persons who are making advance payments on their tax bills. It is also known as payments on account.
- It is crucial to maintain accurate records of business transactions.
A comparison between PAYE and self-assessment:
It is of utmost importance for self-employed workers to understand the differences between PAYE and self-assessment since only after grasping the contrasting points between the two approaches can they truly make an informed decision regarding their tax matters.
Who signs up for PAYE and self-assessment?
To begin with, PAYE is typically designed for the employees who receive regular salaries from an employer, including the directors of a limited company. On the contrary, the self-assessment tax returns system is primarily for self-employed individuals, freelancers, and business owners to report and pay their taxes to HMRC.
Managing tax payments:
Under PAYE, tax is deducted automatically or at source, which saves the employees the hassle of manually calculating and paying their taxes.
Contrarily, under Self-Assessment, self-employed individuals must proactively and manually bear the responsibility of managing their taxes. For this purpose, they set aside money to avoid last-minute financial burdens.
National Insurance Contributions (NICs):
Under PAYE employees have Class 1 NICs liability, which is automatically deducted from their salaries.
Conversely, it is compulsory for self-employed individuals to pay Class 2 (i.e., £3.45 per week for the 2024/25 tax year) and Class 4 NICs (9% on profits over £12,570 and 2% on profits above £50,270).
Expense deductions:
Another key difference between PAYE and self-assessment lies in the ability to claim allowable expenses. Self-employed individuals can deduct the expenses necessary for the running of their business from their taxable profits.
Subsequently, it provides them with tax relief, lowering their overall tax liability. In contrast, employees under PAYE have limited chances to claim tax-deductible expenses. To go into detail, they can only deduct expenses that are directly related to their job and have not been reimbursed by their employer.
As an outcome, PAYE makes their options for expense claims much narrower for the employees than those available to self-employed individuals.
To know more about the tax-deductible expenses for self-employed workers, read our guide:
What are allowable expenses for self-employed people in the UK?
Record-keeping responsibilities:
Fortunately, PAYE is more straightforward since the tax deductions are done automatically. Furthermore, it does not involve the administrative burden, such as record keeping, since the employers manage it for the employees. On the flip side, self-assessment offers greater control over finances but requires thorough planning and detailed records of income and expenses.
Tax payment frequency:
Another significant difference between PAYE and self-assessment is based on the frequency of submitting the tax payments. For instance, the tax under PAYE is submitted on a monthly basis after the employers have deducted them from employees’ wages. On the other hand, self-assessment tax returns can be submitted twice a year (January and July).
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How Accountingfirms can assist you with PAYE and self-assessment?
For self-employed individuals, handling taxes, whether through PAYE or self-assessment, can be a time-consuming and cumbersome task if dealing with taxes is not to their liking.
Accordingly, Accountingfirms facilitate them by connecting self-employed individuals with affordable and location-based accountants who can assist with:
- Registering for self-assessment with HMRC.
- Accurate calculation of taxes and their submission on time to avoid penalties.
- Claiming allowable expenses to reduce taxable income, which, in turn, will cut down your tax bill.
- Comprehensive consultation on tax-saving strategies tailored to self-employed workers.
If you are keen on knowing how you can drastically shed your tax liabilities as a self-employed individual, our following guides can serve the purpose:
How to save taxes as self-employed workers in the UK?
What is the capital allowance for self-employed workers?
How to claim a capital allowance for self-employed workers?
Conclusion:
To summarise, understanding the differences between PAYE and self-assessment is essential for self-employed individuals, to ensure efficient tax planning. On the one hand, PAYE offers the convenience of automatic deductions.
On the other hand, self-assessment gives flexibility and control over tax obligations. Consequently, which option will be more suitable depends on an individual’s employment structure and income sources.
Nevertheless, tax-related stress is something that self-employed people usually steer clear of. Therefore, to ensure compliance with HMRC regulations, working with a registered accountant from Accountingfirms can be of immense help.
The expertise of a skilled accountant ensures that self-employed individuals efficiently manage PAYE, self-assessment, and tax obligations to optimise tax while also staying compliant with HMRC regulations.
Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.