Are Partners Really Self-employed, and What's the Deal with Taxes?

Once you become a partner in a law firm, you are very likely to become self-employed for tax purposes. There will be changes in the timing and amount of your tax payments and a new level of complexity in your personal tax return. In this post, we discuss the tax implications of partnership and ask, what does that mean for your tax planning in these early months and years?

Are you self-employed?

HMRC applies stringent rules to determine whether a partner is an employee or self-employed for tax purposes. To be treated as self-employed, you must satisfy at least one of the following three tests:

• Your salary or draw is not entirely fixed, i.e. it varies with the overall profitability of the partnership;
• You have significant influence over the partnership affairs; and
• You have made a capital contribution.

If you meet these tests, you will need to inform HMRC within three months of becoming self-employed.

Why does this matter?

Your tax regime fundamentally changes when you become self-employed. Firstly, you’ll be responsible for paying tax to HMRC in three tranches – two payments on account on 31 January and 31 July each year, plus a final balancing payment due 31 January after the end of the tax year.

Secondly, you’ll pay Class 2 and Class 4 National Insurance Contributions instead of the Class 1 NICs that you’re used to.

Class 2 NICS are currently a fixed rate of ￡3.15 per week. Class 4 NICS are based on the level of profits, and currently stand at 10.25% for earnings between ￡9,569 and ￡50,270 and 3.25% for earnings over this amount. This includes the government’s recent 1.25 percentage point rise to help pay for health and social care.

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

But I thought I’d already paid....

If that sounds straightforward, understand that new partners are subject to a 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.

The bottom line

Thanks to the payment-on-account and overlap rules, it may be some time after you become a partner that you actually make your first tax payment, and it can be difficult to calculate how much you will be liable to pay. It’s vital that you take advice on your potential tax liability in your circumstances, and make sure that you have enough money available at the right time so you’re not caught short or hit with late-payment penalties.

Did this article give you food for thought? Then you’ll enjoy our deep dive into “10 Financial Mistakes to Avoid When You Make Partner”. Download our full white paper here.