Expenses guide for the self-employed
There are a lot of guide out there about expenses you can claim if you’re an employee.
But what if you’re a sole trader or a partner in a partnership, and therefore self-employed, not an employee?
Here’s a quick look at some of the issues relating to out-of-pocket expenses. That means business expenses that you pay for on a personal credit card or using cash out of your own back pocket, that you’d like your business to pay you back for.
There’s no legal difference
When you’re a sole trader or a partner, there’s no legal difference between you and your business.
Legally, you are the business.
This has ramifications about what can happen if, heaven forbid, your business goes down the tubes.
But it’s also important in this area.
Because legally you are the business, there are no tax implications of money you take out of, or put into, the business.
Yes, you did read that correctly.
When you’re a sole trader or a partner, you can take out as much cash as you like from the business account and HMRC won’t come after you.
That’s completely different from employees (which includes directors of a limited company). Employees and directors are subject to restrictions as to how much, and how, they can be paid. You aren’t.
You can buy yourself a private jet, take that money from the business bank account and HMRC won’t turn a hair.
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They will only get upset if you then put that private jet through the business’s accounts and try and claim tax relief on it.
Or, of course, if you take so much out that you can’t pay the business’s dues and it subsequently goes down the tubes.
So what’s the issue then?
For a sole trader or partner, the main issue is that your business’s accounts mustn’t contain any expenses that aren’t “wholly and exclusively” for the business’s trade.
So if you do buy that private jet, and you use it 50% for business, you can put 50% of the costs of running the jet through the business’s accounts.
But the other 50% is private expenses and must be kept out of the business’s accounts - or alternatively, if you put it in, you must add it back as “disallowable” expenses when you do your tax return.
This is because you’re not entitled to reduce your tax bill for any private expenses.
How do I deal with private expenses in my accounts?
If you do spend any money from your business account for private expenses, like your weekly food bill from the Co-op (a bit more realistic than a private jet!), you must explain that as Drawings in your accounts.
In FreeAgent, that means you explain the payments as Money Paid to User > Drawings.
When you’re a sole trader or partner, you’ve got to put any money you take out of your business account as Drawings. That includes not only private expenses, but also any regular wage-like sums that you take out (sole traders and partners aren’t employees, so can’t go on the payroll and be paid a wage).
And it also includes any money you pay into a pension.
Drawings are kept out of your business’s profit and loss account so that you don’t claim tax relief on them by mistake.
In FreeAgent, you’ll find them at the bottom of your balance sheet.
HMRC’s recently enhanced penalty regime means they can come down hard on any businesses who haven’t kept full and accurate records, which includes keeping track of what costs count as business and which ones as private.
“You should be able to show clearly what you have spent personally and what you have spent on business.”
So make sure you explain your costs correctly in your books.
What business expenses don’t count as “wholly and exclusively”?
There are some areas where you have to be careful.
If you spend money on something that’s for mixed business and private use, then unless you can accurately identify part of it that’s just for business and part that’s private, you can’t put any of the cost through your business accounts. It’s all got to go to Drawings.
HMRC call this the “dual purpose” test. If you had a personal reason for incurring the expense, even if you also had a business reason for it, then the expense would be disallowed in its entirety - unless it could be accurately split between part that was for business and part for private.
For example, buying ordinary clothes will nearly always fail the dual purpose test and have to go to Drawings, because you can’t distinguish between the business and private part of this expense.
That applies even if you buy a business suit that you wouldn’t wear anywhere else apart from on business. You could wear it elsewhere, so HMRC stamp on it. (No, they don’t stamp on the suit. They stamp on you claiming tax relief on it.)
On the other hand, protective clothing, or a uniform, or a “costume” if you’re an actor or other entertainer, would usually pass the test and be OK for inclusion in the business’s expenses.
There are detailed rules covering travel and accommodation expenses, which are perhaps the most frequent potentially “dual purpose” expenses.
Guidance from HMRC starts here.
If you’re a sole trader or a partner, then you’re not subject to the same restrictions as employees (including company directors) when it comes to taking money out of the business, because legally you are the business.
But you must still make sure you put anything you draw out of the business, which includes private expenses, to the correct place in your accounts - which is almost certainly Drawings.
Disclaimer: This article is for general guidance only and is no substitute for taking professional advice related to your own circumstances.