Income tax is a tax that individuals, freelancers, contractors and self-employed individuals pay on their income.
Your income is what you earn from selling products and services. You have to pay tax on this amount. The tax is used to fund public services.
If you run a business it’s called corporate tax. For individuals, freelancers, contractors and sole traders it’s usually called income tax.
Income tax for self-employed individuals
Tax for businesses is calculated using, among other things, the income statement that they submit as part of their annual report.
To calculate how much tax you’ll have to pay, you should first find your total revenue by adding up your earnings from sales of goods and services, sales of assets, and revenue from interest, for example on bank deposits.
To find your net income—your taxable income—you then have to subtract all your fixed costs and variable costs from the total revenue. This is because you get tax deductions for all the costs you incur when you’re self employed.
See also: Understanding tax deductions
Fixed costs are costs that stay the same no matter how many goods and services you produce and sell, such as rental costs and insurance costs. Variable costs are directly related to the sale of goods and services, such as raw materials and shipping costs.
At the end you’ll be left with your net revenue, which is what you have to pay tax on.
Self-employed income versus personal income
If you’re self-employed, business income is combined with personal income, for example salaries and interest on your personal bank deposits. The total income is then taxed at a rate that varies from country to country.
If you start a business, the business will be taxed as one entity, while you’ll have to pay personal income tax on everything you earn as an individual.