Tax Implications of Starting a Business While Still Employed
- Adil Akhtar
- May 8
- 17 min read
Index:
The Audio Summary of the Key Points of the Article:
Understanding the Tax Basics When You’re Employed and Starting a Business
So, you’re thinking about launching a side hustle while keeping your day job? That’s a brilliant way to test the entrepreneurial waters, but it comes with a tax maze you’ll need to navigate. Starting a business while employed in the UK means juggling two income streams, and HMRC will want their cut from both. Let’s break down the essentials to keep you on the right side of the taxman in 2025.
Why Dual Income Streams Matter for Tax
Now, if you’re earning a salary and running a business, you’re dealing with two types of income: employment income (taxed via PAYE) and self-employment or company income (taxed via Self Assessment or Corporation Tax). The good news? You only get one Personal Allowance—£12,570 for the 2025/26 tax year—to offset your total taxable income. Once your combined earnings exceed this, you’ll pay Income Tax at 20% (Basic Rate up to £50,270), 40% (Higher Rate up to £125,140), or 45% (Additional Rate above £125,140). If your side business pushes your total income into a higher tax band, you could see a bigger tax bill than expected.
Sole Trader vs. Limited Company: Tax Implications
Alright, let’s talk about your business structure, as it’s a game-changer for taxes. Most people starting a side hustle go for sole trader status because it’s simple—you register with HMRC, report profits on your Self Assessment, and pay Income Tax and National Insurance (NI) on those profits. For 2025/26, if your profits exceed £12,570, you’ll pay Class 2 NI (£3.45 weekly) and Class 4 NI (6% on profits between £12,570 and £50,270, then 2% above that).
On the other hand, setting up a limited company means your business is a separate legal entity. You’ll pay Corporation Tax (19% for profits up to £50,000, 25% above £250,000, with Marginal Relief in between) on company profits. If you pay yourself a salary or dividends, those are taxed via Self Assessment. Dividends have lower tax rates (8.75% Basic, 33.75% Higher, 39.35% Additional for 2025/26), which can be tax-efficient if you keep your salary low. But, you’ll need to register as an employer for PAYE if you take a salary, and there’s more paperwork—Company Tax Returns, annual accounts, and confirmation statements.
Which business structure should I choose for tax optimisation?
Table 1: Tax Rates for Sole Trader vs. Limited Company (2025/26)
Income Type | Sole Trader | Limited Company |
Tax on Profits | Income Tax (20%, 40%, 45%) + NI (Class 2 & 4) | Corporation Tax (19%–25%) |
Personal Income | Profits taxed via Self Assessment | Salary (PAYE) + Dividends (Self Assessment) |
Dividend Tax Rates | N/A | 8.75% (Basic), 33.75% (Higher), 39.35% (Additional) |
Admin Burden | Low (Self Assessment only) | High (Company Tax Return, PAYE, accounts) |
The Trading Allowance: A Hidden Gem
Here’s a little trick you might love: the Trading Allowance lets you earn up to £1,000 from self-employment (like selling crafts or freelancing) without declaring it to HMRC. If your side hustle earns less than this in the 2025/26 tax year, you don’t need to register as self-employed or file a Self Assessment return. But, if you earn more, you must register by 5 October 2026 and report all income, though you can deduct the £1,000 allowance to reduce taxable profits. This is perfect for small side gigs, but beware—claiming the allowance means you can’t deduct actual business expenses, so crunch the numbers to see what’s better.
Case Study: Elowen’s Etsy Shop
Let’s paint a picture with Elowen, a graphic designer from Cornwall. She’s employed full-time, earning £35,000 a year, and starts an Etsy shop selling prints in 2025. Her shop makes £8,000 in sales, with £2,000 in expenses. As a sole trader, she registers with HMRC and uses the Trading Allowance, reducing her taxable profit to £7,000 (£8,000 - £1,000). Her total income (£35,000 + £7,000 = £42,000) stays in the Basic Rate band, so she pays 20% Income Tax (£5,886 after her Personal Allowance) plus Class 4 NI (6% on £7,000 = £420). If she claims actual expenses instead, her profit is £6,000 (£8,000 - £2,000), saving her a bit on tax. Elowen’s story shows how the Trading Allowance can simplify things, but comparing options is key.
PAYE and Your Day Job: Avoiding the Emergency Tax Trap
Now, it shouldn’t be a surprise that your employer handles your Income Tax and NI through PAYE, using a tax code (usually 1257L for the full Personal Allowance). If you start a business, HMRC might adjust your tax code to account for your side income, especially if you’re a sole trader. This can lead to emergency tax if HMRC underestimates your total income, leaving you overtaxed during the year. For example, if your business profits push you into the Higher Rate band, your employer might deduct too much tax from your salary until your Self Assessment balances things out. To fix this, contact HMRC early to update your tax code or expect a refund after filing your return.
Registering with HMRC: Deadlines You Can’t Miss
Be careful! If you’re going sole trader and earn over £1,000, you must register with HMRC for Self Assessment by 5 October following the tax year you started trading (e.g., 5 October 2026 for 2025/26). Miss this, and you could face a penalty. For a limited company, register for Corporation Tax within three months of trading, and if you pay yourself a salary, set up PAYE. Online filing deadlines are 31 January (e.g., 31 January 2026 for 2024/25), and you must pay any tax owed by then too. Paper returns are due earlier—31 October—so go digital to save stress.
Basis Period Reform: A New Twist for Sole Traders
Now consider this: If your business doesn’t align its accounting year with the tax year (6 April to 5 April), HMRC’s Basis Period Reform (fully in effect for 2024/25) changes how you report profits. You’ll need to apportion profits to the tax year, which can be a headache if your accounts end on, say, 31 December. For instance, if your business starts 1 October 2025 and makes £45,000 profit by 30 September 2026, you’d report £23,054 for 2025/26 (187 days from 1 October 2025 to 5 April 2026). This reform aims to simplify things long-term but can complicate your first few returns, so consider aligning your accounting date to 5 April.
Actionable Tip: Keep Records Like a Pro
None of us is a tax expert, but good record-keeping makes life easier. Track all business income and expenses (e.g., materials, travel, home office costs) using software like FreeAgent or QuickBooks. For sole traders, claim allowable expenses (like a portion of your broadband if you work from home) to reduce taxable profits. Limited companies can claim similar expenses, but ensure they’re wholly for business use. Keep receipts and invoices for six years—HMRC can audit you, and you’ll thank yourself for being organised.
Managing Overlapping Tax Obligations and Avoiding Pitfalls
Right, so you’ve got the basics of juggling a job and a side business, but now it’s time to dig into the nitty-gritty of keeping your tax obligations in check. When you’re employed and running a business, HMRC’s watching both income streams, and there are plenty of traps to dodge. Let’s explore how to manage your taxes smartly, avoid overpaying, and make the most of reliefs in 2025.
National Insurance: The Double Whammy
Now, nobody loves paying National Insurance twice, but if you’re employed and self-employed, that’s exactly what happens. Your day job deducts Class 1 NI through PAYE (12% on earnings between £12,570 and £50,270, 2% above that for 2025/26). If you’re a sole trader, you’ll also pay Class 2 NI (£3.45 weekly if profits exceed £12,570) and Class 4 NI (6% on profits between £12,570 and £50,270, 2% above). The catch? You might hit the NI ceiling if your combined income is high, but HMRC doesn’t automatically refund overpayments. You’ll need to apply for a deferment before the tax year starts or claim a refund via Self Assessment. For limited companies, you avoid Class 2 and 4 NI, but if you pay yourself a salary, Class 1 NI applies.
Table 2: National Insurance Contributions (2025/26)
Type | Employed (Class 1) | Sole Trader (Class 2 & 4) | Limited Company |
Threshold | £12,570 (Primary Threshold) | £12,570 (Small Profits Threshold) | N/A (Salary-dependent) |
Rates | 12% (£12,570–£50,270), 2% above | Class 2: £3.45/wk; Class 4: 6% (£12,570–£50,270), 2% above | Class 1 if salary paid |
Max Contribution | ~£5,085 (if earning >£50,270) | No cap on Class 4 | Depends on salary |
Refund Process | Automatic via PAYE or Self Assessment | Apply for deferment or refund | PAYE handles salary NI |
National Insurance Contributions (2025/26)
Tax Codes and Overpayment Risks
Be careful! Your PAYE tax code can get messy when you add business income. HMRC might lower your tax code (e.g., from 1257L to 1000L) to collect more tax from your salary, anticipating your side income. But if they overestimate your business profits, you could be overtaxed all year. For example, Idris, a Manchester-based teacher earning £40,000, starts a tutoring business making £10,000 profit. HMRC adjusts his tax code, assuming £15,000 profit, so he pays an extra £1,000 in tax via PAYE. He gets it back after filing his Self Assessment, but it’s cash flow he’s missed for months. To avoid this, update HMRC with accurate profit estimates via your Personal Tax Account on GOV.UK.
Allowable Expenses: Squeeze Every Penny
So, the question is: How do you reduce your taxable profits? Claim allowable expenses—costs wholly and exclusively for your business. Sole traders can claim things like office supplies, travel, or a portion of home costs (e.g., 20% of electricity if you use a home office). Limited companies claim similar expenses, but you must prove they’re business-related, and you can’t claim personal use. Use the simplified expenses scheme if your business is small—e.g., flat rates for vehicle costs (£0.45 per mile for cars) or working from home (£6 weekly). In 2025, HMRC’s cracking down on incorrect claims, so keep detailed records and avoid claiming your morning coffee unless it’s a client meeting.
Case Study: Tariq’s Freelance Coding Gig
Let’s look at Tariq, a Bristol-based IT worker earning £45,000. In 2025, he starts freelancing as a coder, earning £20,000 with £5,000 in expenses (laptop, software, home office). As a sole trader, he claims actual expenses, reducing his taxable profit to £15,000. His total income (£45,000 + £15,000 = £60,000) pushes him into the Higher Rate band, so he pays 40% on £9,730 (£60,000 - £50,270), plus 20% on the rest after his Personal Allowance. His NI includes Class 4 (6% on £15,000 = £900) and Class 2 (£3.45 x 52 = £179.40). If he’d used the Trading Allowance instead, he’d pay tax on £19,000 (£20,000 - £1,000), costing him more. Tariq’s case shows why calculating expenses versus allowances is crucial.
Pension Contributions: A Tax-Saving Hack
Now consider this: If your side business boosts your income, pension contributions can lower your tax bill. In 2025/26, you can contribute up to £60,000 or your total earnings (whichever is lower) to a pension and get tax relief at your marginal rate (20%, 40%, or 45%). For example, if you earn £60,000 total and contribute £10,000 to a pension, you reduce your taxable income to £50,000, staying in the Basic Rate band. Sole traders claim this via Self Assessment; limited company directors can have the company pay into their pension, reducing Corporation Tax. Check with a financial adviser to ensure your pension scheme qualifies, as HMRC’s rules are strict.
VAT: Do You Need to Register?
Here’s something to watch out for: If your business turnover (sales, not profit) hits £90,000 in any 12-month period in 2025, you must register for VAT. For a side hustle, this is rare, but if you’re selling high-value services (e.g., consultancy), it’s possible. Once registered, you charge 20% VAT on sales, reclaim VAT on business purchases, and file quarterly VAT returns. You can voluntarily register below £90,000 to reclaim VAT, but it adds admin. The Flat Rate Scheme (e.g., 14.5% for consultants) simplifies things for small businesses, but weigh the pros and cons—reclaiming actual VAT might save more.
Working from Home: Claiming Costs
None of us wants to miss out on deductions, right? If you run your business from home, claim a portion of costs like rent, council tax, or utilities. Calculate this based on the space used and time spent working. For example, if one of five rooms is your office and you work there 50% of the time, claim 10% (1/5 x 50%) of eligible costs. In 2025, HMRC allows simplified expenses (£6 weekly) or actual costs, but you’ll need evidence like utility bills. Limited companies can reimburse you for home office costs, but keep a formal agreement to satisfy HMRC.
Actionable Tip: Use a Separate Bank Account
Hey, don’t sweat it—keeping your business and personal finances separate isn’t hard and saves headaches. Open a business bank account (many are free for sole traders) to track income and expenses. This makes Self Assessment or Company Tax Returns easier and shows HMRC you’re legit if audited. For limited companies, it’s a legal must. Apps like Starling or Monzo offer instant setup and integrate with accounting software, making 2025 tax prep a breeze.
UK Tax Navigator: Business & Employment Tax Implications (2020-2025)
Planning Ahead: Tax Strategies and Long-Term Considerations
Okay, you’re now clued up on the tax basics and how to avoid common pitfalls, but what about playing the long game? Running a side business while employed means thinking strategically to minimise your tax bill and plan for growth. Let’s dive into advanced strategies, future-proofing your finances, and handling tricky scenarios in 2025.
Tax Planning: Timing Your Income
So, here’s a clever move: timing your business income can save you tax. If you’re a sole trader, you can delay invoicing clients until after 5 April to push profits into the next tax year, especially if your combined income is close to a higher tax band. For example, if you earn £45,000 from your job and expect £10,000 from your business in 2025/26, delaying £5,000 to 2026/27 keeps you in the Basic Rate band. Limited companies can do this by retaining profits in the company and paying dividends later, as dividends are taxed at lower rates (8.75% Basic, 33.75% Higher, 39.35% Additional). Just ensure you don’t delay so long that clients chase you!
Table 3: Income Tax Bands and Strategies (2025/26)
Tax Band | Income Range | Tax Rate | Strategy |
Personal Allowance | £0–£12,570 | 0% | Maximise allowance across both incomes |
Basic Rate | £12,571–£50,270 | 20% | Delay income to stay in this band |
Higher Rate | £50,271–£125,140 | 40% | Use pensions or EIS to reduce taxable income |
Additional Rate | £125,141+ | 45% | Retain profits in company for dividends |
Capital Allowances: Boost Your Deductions
Now, if you’re investing in equipment—like a laptop or van—don’t miss capital allowances. In 2025, the Annual Investment Allowance (AIA) lets you deduct up to £1 million on qualifying assets in the year you buy them, reducing your taxable profits. For sole traders, this lowers your Income Tax; for limited companies, it cuts Corporation Tax. If you spend less, claim 100% First-Year Allowances on energy-efficient equipment. For example, Lowri, a Cardiff-based photographer earning £30,000 from her job, buys a £5,000 camera for her side hustle. She claims the full amount via AIA, slashing her taxable business profit. Check HMRC’s list of qualifying assets on GOV.UK to ensure eligibility.
Case Study: Siôn’s Coffee Van Venture
Let’s meet Siôn, a Newcastle nurse earning £38,000, who starts a coffee van business in 2025, making £25,000 profit after £10,000 in expenses (van, coffee machine). As a sole trader, his total income (£38,000 + £25,000 = £63,000) pushes him into the Higher Rate band. He claims AIA for the £8,000 coffee machine, reducing his taxable profit to £17,000, saving £3,200 in tax (40% of £8,000). Siôn also contributes £5,000 to his pension, lowering his taxable income to £58,000, keeping more in the Basic Rate band. His story shows how combining allowances and pensions can make a big difference.
Loss Relief: Turning Setbacks into Savings
Be careful! If your side business makes a loss (common in the early days), you can use loss relief to offset it against other income. Sole traders can offset losses against their employment income in the same tax year or carry them forward to future business profits. For example, if your business loses £5,000 in 2025/26, you can reduce your taxable employment income, potentially getting a tax refund. Limited companies don’t get this relief personally, but losses can reduce future Corporation Tax. File losses accurately in your Self Assessment, as HMRC scrutinises claims—especially for hobby businesses.
SEIS and EIS: Tax Breaks for Investors
Now consider this: If you’re scaling your limited company and seeking investors, the Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) can benefit both you and your investors. Investors get Income Tax relief (50% for SEIS, 30% for EIS) on their investment, and you can raise up to £250,000 (SEIS) or £5 million (EIS) annually. As a director, you can’t claim the relief yourself, but it makes your business attractive to angel investors. In 2025, HMRC’s tightened SEIS/EIS rules, so consult a tax adviser to ensure compliance—paperwork errors can disqualify you.
Transitioning to Full-Time Entrepreneurship
So, the question is: What if your side hustle takes off? Transitioning to full-time self-employment or company ownership changes your tax setup. You’ll lose PAYE’s simplicity, so budget for tax payments (Self Assessment for sole traders, PAYE/Corporation Tax for companies). If you stay a sole trader, your NI switches to Class 2 and 4 only. For limited companies, optimise your salary-dividend mix—many directors take a low salary (£9,100 in 2025/26, below NI thresholds) and top up with dividends to minimise tax. Plan this transition early, as cash flow can take a hit without a regular paycheck.
HMRC Investigations: Stay Audit-Ready
None of us wants a letter from HMRC, right? But running a side business increases your audit risk, especially if your expenses seem high or profits fluctuate. In 2025, HMRC’s using AI to spot discrepancies in Self Assessment and Company Tax Returns. Keep detailed records—bank statements, receipts, invoices—for six years. If you’re a sole trader, ensure personal and business expenses are separate. Limited companies need accurate payroll and VAT records. If audited, respond promptly and consider hiring an accountant to negotiate with HMRC.
Actionable Worksheet: Tax Planning Checklist
Hey, don’t sweat it—here’s a quick checklist to stay on top of your taxes in 2025:
Track Income: Use accounting software to log all business income and expenses.
Estimate Profits: Update HMRC with profit estimates to avoid tax code errors.
Claim Expenses: Record allowable costs and capital allowances to reduce taxable profits.
Save for Tax: Set aside 20–30% of business income for Income Tax and NI.
Review Structure: Reassess sole trader vs. limited company annually as profits grow.
File Early: Submit Self Assessment by 31 January to avoid penalties.
Plan Pensions: Contribute to a pension to lower your taxable income.
Download a free template from GOV.UK to start organising your records.
Future-Proofing: Watch for Tax Changes
Alright, let’s think ahead. The UK’s tax landscape shifts regularly, and 2025/26 could see tweaks to NI rates or VAT thresholds post-Budget. Follow HMRC’s updates on GOV.UK or subscribe to tax newsletters from firms like Deloitte or PwC. If your business grows, consider hiring an accountant—they’ll spot reliefs you might miss and handle complex filings. For now, focus on compliance, claim every deduction, and keep your side hustle thriving without tax stress.
Which tax strategy should I use based on my income band?
Summary of All the Most Important Points Mentioned In the Above Article
Starting a business while employed in the UK means managing two income streams, with only one Personal Allowance (£12,570 in 2025/26) to offset total taxable income.
As a sole trader, you pay Income Tax and National Insurance (Class 2 and 4) on business profits, while a limited company pays Corporation Tax (19%–25%) and taxes salary/dividends separately.
The Trading Allowance lets you earn up to £1,000 from self-employment tax-free, but claiming it prevents deducting actual expenses.
HMRC may adjust your PAYE tax code for business income, risking overtaxation if profits are misestimated, so update estimates via your Personal Tax Account.
Claim allowable expenses (e.g., home office costs, travel) and capital allowances (up to £1 million via AIA) to reduce taxable profits for both sole traders and limited companies.
If your business turnover exceeds £90,000, you must register for VAT, charge 20% on sales, and file quarterly returns, though voluntary registration can help reclaim VAT.
Pension contributions (up to £60,000 or total earnings) reduce taxable income, with tax relief at your marginal rate, benefiting both sole traders and company directors.
Time business income (e.g., delay invoicing) to stay in lower tax bands, and use loss relief to offset business losses against employment income.
SEIS and EIS schemes attract investors with tax relief (50% and 30%), helping limited companies raise funds, but compliance is strict.
Keep detailed records, use a separate business bank account, and file Self Assessment by 31 January to avoid penalties and prepare for potential HMRC audits.
FAQs
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The Author:
Adil Akhtar, ACMA, CGMA, CEO and Chief Accountant of Pro Tax Accountant, is an esteemed tax blog writer with over 10 years of expertise in navigating complex tax matters. For more than three years, his insightful blogs have empowered UK taxpayers with clear, actionable advice. Leading Advantax Accountants as well, Adil blends technical prowess with a passion for demystifying finance, cementing his reputation as a trusted authority in tax education.
Email: adilacma@icloud.com
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