Inadequate Provision for Self-employed taxes

Until now, the firm will have deducted income tax and national insurance from your salary under the PAYE scheme. Subject to any other sources of income, this results in a simple personal tax return and a small settlement to or from HMRC each year.

Now that you are a partner, you are very likely to become self-employed for tax purposes—and your personal tax return is about to get a lot more complicated.

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Three diary dates

As a self-employed person, you are responsible for paying tax in three tranches:

• The first payment on account, due 31 January in the tax year, based on 50% of your previous year’s tax liability
• Second payment on account, due 31 July after the end of the tax year, based on 50% of your previous year’s tax liability
• Balancing payment, due 31 January after the end of the tax year, which is the actual tax and national insurance due to fewer payments on account.

It’s up to you to pay your tax on time. If payments are wrong, the excuse of “my firm did it for me” will cut no ice with HM Revenue & Customs.

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National Insurance when you’re self employed

National Insurance contributions are also different for both the firm and the individual member of an LLP.

In an employment situation, Class 1 National Insurance Contributions are payable by the employer, subject to certain thresholds, usually at the rate of 13.8%. Once an employee becomes an LLP member and thus self-employed, the firm no longer makes this payment.

Employees also pay Class 1 National Insurance Contributions, subject to certain thresholds, usually at the rate of 12% (2% for income above the upper earnings limit). This is deducted from gross pay through the payroll each month. Again, once an individual becomes self-employed, they no longer make this payment. Instead, Class 2 and Class 4 National Insurance Contributions kick in, which the self-employed partner remits themselves to HMRC.

Class 2 NICS are currently a fixed rate of ￡3.45 per week. Class 4 NICS are based on the level of profits, and currently stand at 9% for earnings between ￡12,570 and ￡50,270 and 2% for earnings over this amount. Some law firms will retain money from drawings in order to pay tax and NICs; however, most people pay through their Self Assessment tax return.

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But I thought I’d already paid….

If that sounds straightforward, understand that new partners are subject to a terribly confusing concept called overlap profits. This can result in what will feel like double tax in your first year.

Overlap profits remain a mystery and you’ll need specialist tax advice to fully understand what’s going on. But it boils down to HMRC wanting to make sure that you start paying tax on your share of the partnership profits as soon as possible, so you likely will be taxed more than once on some profits in the first 1 to 3 years.

In other words, there’s an additional tax burden that you may not have accounted for. You won’t get this money back until you retire.

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How much have you set aside?

Thanks to the payment-on-account rules, it may be some time after you become a partner that you actually make your first tax payment. It’s a good idea to take advice on the potential tax payments in your circumstances, and make sure that your accruing liability is set aside and available at the right time—particularly in the first, second and possibly third year as a self-employed person when overlap rules are in play.

If you are unsure about the financial implications of becoming self-employed once making partner, I would be happy to run you through what it means and discuss the best options for you. You can book a no-obligation 15-minute call free of charge with me here: https://calendly.com/adrian-pwp/15min_introductorycall