# What Expenses Do Freelancers Need to Track for Making Tax Digital in 2026? Last updated: 16 October 2026 From April 2026, freelancers with gross income over £50,000 must digitally track all allowable business expenses using MTD-compatible software to comply with Making Tax Digital for Income Tax Self Assessment (MTD ITSA), ensuring quarterly reporting and accurate final tax declarations. This includes office costs, travel, marketing, professional fees, and equipment, all recorded 'wholly and exclusively' for business purposes. ## Understanding the Impact of Making Tax Digital for Income Tax Self Assessment (MTD ITSA) on Freelancers The landscape of tax reporting for self-employed individuals in the UK is undergoing a significant transformation with the introduction of Making Tax Digital for Income Tax Self Assessment (MTD ITSA). For freelancers, sole traders, and landlords, this initiative, commencing in April 2026 for many, marks a pivotal shift from traditional annual tax returns to a system of quarterly digital reporting. The core objective of MTD ITSA is to modernise the tax system, reduce errors, and provide taxpayers with a more real-time view of their tax position. However, for freelancers, it fundamentally elevates the importance of meticulous and continuous expense tracking. Prior to MTD ITSA, many freelancers might have gathered their income and expense records once a year, often just before the Self Assessment deadline. With MTD ITSA, this approach will no longer be compliant. The new regulations mandate digital record-keeping and the submission of income and expense summaries to HM Revenue and Customs (HMRC) on a quarterly basis. This means that consistent, accurate, and digital tracking of every allowable business expense will become an ongoing operational necessity, rather than an annual task. Understanding what expenses are allowable, how to record them correctly, and the new reporting rhythm is paramount for ensuring compliance and optimising tax efficiency under the new regime. This guide will delve into the specifics of expense tracking for freelancers in the MTD ITSA era, providing clarity on categories, methodologies, and the tools that can facilitate this crucial aspect of business management. ### What is MTD ITSA and why is it important for freelancers? Making Tax Digital for Income Tax Self Assessment (MTD ITSA) is HMRC's programme to digitalise the tax system for self-employed individuals and landlords. It moves away from the traditional annual Self Assessment tax return towards a system of digital record keeping and regular, quarterly updates to HMRC. For freelancers, MTD ITSA is important for several key reasons: 1. **Mandatory Digital Record Keeping:** It will become a legal requirement for eligible freelancers to keep their business records digitally, using MTD-compatible software. This means no more paper ledgers or simple spreadsheets unless they are linked to bridging software. 2. **Quarterly Reporting:** Instead of one annual tax return, freelancers will need to submit summaries of their business income and expenses to HMRC every three months. This provides HMRC with a more frequent overview of business activity. 3. **End of Period Statement (EOPS) and Final Declaration:** After the four quarterly updates, an End of Period Statement (EOPS) will be submitted to finalise the business's profits and losses for the tax year. This is followed by a Final Declaration, which includes all other income sources and claims for allowances, replacing the current Self Assessment tax return. 4. **Improved Accuracy and Reduced Errors:** By requiring more frequent and digital record keeping, MTD ITSA aims to reduce the number of errors made in tax returns, which often arise from last-minute compilation of records. 5. **Real-time Tax Position:** The quarterly updates can provide freelancers with a more up-to-date estimate of their tax liability throughout the year, enabling better financial planning and budgeting for tax payments. In essence, MTD ITSA is not just a change in how you report, but a fundamental shift in how you manage your financial records day-to-day. For freelancers, this means integrating robust digital accounting practices into their regular workflow. ### When does MTD ITSA come into effect for freelancers? The implementation of MTD ITSA has been phased to allow businesses time to adapt. For freelancers and landlords, the mandatory start dates are: * **April 2026:** MTD ITSA becomes mandatory for self-employed individuals and landlords with a gross income from all businesses and properties exceeding **£50,000** in a tax year. * **April 2027:** MTD ITSA becomes mandatory for self-employed individuals and landlords with a gross income from all businesses and properties between **£30,000 and £50,000** in a tax year. For those with gross income below £30,000, a mandatory start date is yet to be confirmed by HMRC. However, these individuals can choose to opt in voluntarily if they wish to benefit from the digital system and prepare for potential future mandates. It is crucial for freelancers to identify their gross income level to determine their mandatory start date. 'Gross income' refers to your total income before any expenses or allowances are deducted. If you fall into the £50,000+ bracket, the 2026/27 tax year (starting 6 April 2026) will be your first MTD ITSA year. ### How does MTD ITSA change expense tracking and reporting? MTD ITSA fundamentally transforms expense tracking and reporting for freelancers in several key ways: 1. **Continuous Digital Record Keeping:** The most significant change is the requirement to keep digital records of all business income and expenses on an ongoing basis. This means transactions must be recorded in MTD-compatible software as they occur, or at least regularly throughout the quarter, rather than compiling them at year-end. 2. **Categorisation Consistency:** Expenses must be categorised accurately and consistently according to HMRC's specified categories within the MTD-compatible software. This ensures that the data submitted in quarterly updates is structured and correct. 3. **Quarterly Summaries:** Instead of a single annual summary, freelancers will need to generate and submit four quarterly summaries of their income and expenses to HMRC. This necessitates having up-to-date and reconciled expense data at the end of each quarter. 4. **Digital Links:** The software used for record keeping must maintain "digital links" between transactions and the quarterly summaries. This means manual re-keying of data between different systems will not be permitted for MTD purposes. 5. **Real-time Oversight:** The regular updates provide a more current view of a freelancer's financial performance and estimated tax liability. This allows for better cash flow management and helps identify potential issues or opportunities earlier in the tax year. 6. **Reduced Year-End Burden (Potentially):** While the quarterly workload increases, the aim is to spread the tax compliance burden throughout the year, potentially reducing the stress and rush associated with the traditional January 31st deadline. The final End of Period Statement and Final Declaration should be simpler as most data will have already been submitted. 7. **Increased Scrutiny:** With more frequent data submissions, there's a possibility of increased HMRC scrutiny if anomalies are detected between quarterly reports or compared to industry benchmarks. Accurate and well-supported expense tracking becomes even more vital. In essence, MTD ITSA demands a proactive, digital-first approach to expense management, making it an integral part of a freelancer's ongoing business operations. ## The Golden Rule: What Makes an Expense Allowable for Tax Purposes? Before diving into specific categories, it is crucial to understand the overarching principle that governs whether an expense can be deducted for tax purposes: the 'wholly and exclusively' rule. This principle is fundamental to calculating your taxable profit and remains unchanged by MTD ITSA, though the *method* of recording these expenses becomes digital. ### Wholly and Exclusively for the Business For an expense to be allowable, it must have been incurred 'wholly and exclusively' for the purposes of your trade, profession, or vocation. This means there should be no significant private or personal element to the expenditure. * **Wholly:** The entire cost must be for the business. * **Exclusively:** The sole purpose of incurring the expense must be for the business. If an expense genuinely meets this criterion, it can be deducted from your gross business income, thereby reducing your taxable profit and, consequently, your Income Tax and Class 4 National Insurance contributions. ### Dual Purpose Expenses Many expenses, particularly for freelancers working from home, can have both a business and a personal use. These are known as 'dual purpose' expenses. Examples include: * Home utility bills (electricity, gas, internet). * Mobile phone bills. * Vehicle running costs (if used for both business and personal travel). For dual-purpose expenses, you can only claim the portion that relates directly to your business use. You must have a reasonable method for apportioning the cost. For instance, you might calculate: * **Home Utilities:** The proportion of rooms used for business and the time spent working in them, or the percentage of floor space dedicated to business. * **Mobile Phone:** The percentage of calls/data used for business. * **Vehicle Costs:** The percentage of mileage driven for business purposes. HMRC offers 'simplified expenses' for certain dual-purpose costs, such as working from home or vehicle use, which can simplify the calculation, though they may not always result in the largest claim. These will be discussed in more detail under the relevant expense categories. ### Capital Expenditure vs. Revenue Expenditure It is important to distinguish between capital expenditure and revenue expenditure when tracking expenses, as they are treated differently for tax purposes. * **Revenue Expenditure:** These are the day-to-day running costs of your business. They are fully deductible against your income in the year they are incurred. Most of the expense categories discussed in this guide fall under revenue expenditure. Examples include stationery, utility bills, marketing costs, and professional fees. * **Capital Expenditure:** These are costs incurred to acquire, improve, or enhance assets that have a lasting benefit to your business (typically for more than two years). You cannot deduct the full cost of these assets as an expense in the year of purchase. Instead, you claim 'capital allowances' over time. Examples include computers, vehicles, office furniture, machinery, or tools. **Annual Investment Allowance (AIA):** For most tangible capital assets (plant and machinery), the Annual Investment Allowance (AIA) allows you to deduct the full cost (up to £1 million per year) from your profits in the year you buy them. This effectively means you can often treat capital expenditure up to this limit as if it were a revenue expense in terms of its immediate tax relief. This is a significant relief for freelancers investing in their business. Under MTD ITSA, you will still need to correctly classify these expenditures. MTD-compatible software will typically have specific categories or functionalities to differentiate between revenue expenses and capital expenditure for proper reporting. ## Detailed Breakdown of Common Allowable Expenses for Freelancers For freelancers, understanding and diligently tracking allowable expenses is paramount for accurate tax reporting under MTD ITSA. Each expense category must adhere to the 'wholly and exclusively' rule. The following breakdown covers common expenses, providing guidance on what to track and how MTD ITSA impacts this process. ### Office Costs Whether you work from a dedicated office or your home, the costs associated with your workspace are often significant and largely allowable. * **Rent, Rates, and Utilities for Business Premises:** If you operate from a rented office, studio, or workshop, the rent, business rates, electricity, gas, and water bills are fully allowable. * **Office Supplies:** Stationery, printer ink, paper, postage, and other consumables are deductible. * **Cleaning and Maintenance:** Costs for cleaning your business premises or minor repairs are allowable. * **Small Equipment:** Items like a new keyboard, mouse, or a small desk lamp are typically revenue expenses. Larger items like computers or significant furniture are capital expenditure (see 'Equipment and Software'). **MTD ITSA Impact:** Digital records of all invoices and receipts for these costs must be kept. Your MTD-compatible software should allow you to easily categorise these under 'Office Costs' or similar, ensuring they are included in your quarterly updates. #### Worked Example: Home Office Simplified Expenses vs. Actual Costs Many freelancers work from home, incurring dual-purpose expenses. HMRC offers two methods for claiming these: **Scenario:** A freelancer, Chloe, works from her spare room for 120 hours per month. **Method 1: Simplified Expenses (Flat Rate)** HMRC provides flat rates for working from home, eliminating the need to calculate actual costs. For 2026/27 (assuming current rates), these are: | Hours Worked from Home per Month | Allowable Monthly Rate | Annual Claim | | :------------------------------- | :--------------------- | :------------ | | 25-50 hours | £10 | £120 | | 51-100 hours | £18 | £216 | | 101+ hours | £26 | £312 | Chloe works 120 hours/month, so she can claim £26 x 12 = **£312** annually. This is simple and requires no detailed breakdown of household bills. **Method 2: Actual Costs (Proportionate Share)** Chloe could calculate the actual business portion of her household bills. Assume her annual household bills are: * Electricity: £800 * Gas: £600 * Internet: £300 * Council Tax: £1,500 * Mortgage Interest (not capital repayment) or Rent: £6,000 If Chloe uses one room (out of 5 main rooms) exclusively for business during her working hours, and works 40% of her waking hours, she might calculate: * Proportion of space: 1/5 = 20% * Proportion of time: 40% (working hours vs. total hours home) * Business use factor: (20% x 40%) = 8% (This calculation can be complex and depends on specific use) Let's use a simpler common calculation: 1/5 of the bills for the office room. * Total relevant bills: £800 + £600 + £300 + £1,500 + £6,000 = £9,200 * Business proportion (20%): £9,200 x 20% = **£1,840** In this example, claiming actual costs results in a much higher deduction (£1,840 vs. £312). However, it requires detailed record-keeping of all household bills and a justifiable method for calculating the business portion. You must choose the method that best suits your circumstances and provides the highest allowable claim while remaining justifiable. **MTD ITSA Consideration:** If choosing actual costs, you must digitally record the underlying household bills and your calculation method. Simplified expenses are easier to record digitally as a single monthly figure. ### Travel Expenses Business-related travel costs are a common and often significant expense for freelancers. * **Fuel, Parking, Tolls, Public Transport:** Costs for journeys undertaken 'wholly and exclusively' for business purposes are allowable. This includes travel to client meetings, training courses, industry events, or to purchase business supplies. * **Vehicle Running Costs:** If you use your personal vehicle for business, you can claim either: * **Simplified Expenses (Mileage Allowance):** A flat rate per mile for business journeys (e.g., 45p per mile for the first 10,000 miles, 25p thereafter for cars/vans). This covers all vehicle running costs (fuel, insurance, repairs, servicing). * **Actual Costs:** A proportion of all actual vehicle costs (fuel, insurance, repairs, MOT, breakdown cover, road tax) based on your business mileage as a percentage of total mileage. This requires meticulous record-keeping of all expenses and a mileage log. * **Accommodation and Subsistence:** Hotel stays and reasonable meal costs incurred during overnight business trips are allowable. * **Hire Charges:** Costs for hiring a vehicle or other transport for business purposes. **What is NOT allowable:** Commuting from your home to a regular place of work (even if it's a client's office you visit daily) is generally not allowable. **MTD ITSA Impact:** Accurate mileage logs (digital is best), fuel receipts, train tickets, and hotel invoices must be digitally stored. Your MTD software should have categories for 'Travel' or 'Motor Expenses' to facilitate this. If using mileage allowance, you just record the business mileage. ### Marketing and Advertising Promoting your freelance services is essential, and these costs are typically fully allowable. * **Website Costs:** Domain name registration, hosting fees, website design, and ongoing maintenance. * **Online Advertising:** Social media ads (Facebook, Instagram, LinkedIn), Google Ads, sponsored content. * **Printed Materials:** Business cards, flyers, brochures, banners for events. * **Directory Listings:** Fees for being listed in online or offline business directories. * **Public Relations:** Costs associated with PR activities to promote your business. **MTD ITSA Impact:** Keep digital records of all invoices from web designers, hosting providers, advertising platforms, and print shops. These expenses will be categorised under 'Marketing & Advertising' in your MTD-compatible software. ### Professional Fees Many freelancers rely on professional advice to run their businesses, and these fees are generally deductible. * **Accountant's Fees:** Costs for preparing your business accounts, filing your Self Assessment tax return, and providing tax advice. * **Legal Fees:** Fees for drawing up business contracts, resolving business disputes, or seeking legal advice related to your trade (excluding fees for buying business property). * **Consultancy Fees:** Payments to other consultants or experts for advice specific to your business operations. **MTD ITSA Impact:** Invoices from accountants, solicitors, and consultants must be digitally recorded. These fall under 'Professional Fees' or 'Accountancy Fees' in your digital records. ### Training and Subscriptions Investing in your skills and staying current in your field is a legitimate business expense. * **Training Courses:** Fees for courses, workshops, or seminars that are directly related to improving existing skills or gaining new skills for your *current* business. * **Professional Body Subscriptions:** Fees for membership of professional organisations relevant to your freelance work (e.g., a graphic design association, a freelance writers' guild). * **Trade Magazine/Journal Subscriptions:** Subscriptions to publications that provide industry-specific knowledge. **What is NOT allowable:** Training courses that lead to a *new* qualification for a *new* trade or profession are generally not allowable. For example, a web designer cannot claim for a medical degree. **MTD ITSA Impact:** Digital receipts or invoices for course fees and subscription renewals are essential. Categorise these under 'Training' or 'Subscriptions' in your MTD software. ### Financial Costs The costs associated with managing your business finances are also allowable. * **Bank Charges:** Fees for your business bank account, overdraft charges, or transaction fees. * **Interest on Business Loans:** Interest paid on loans taken out specifically for business purposes (e.g., to purchase equipment, fund working capital). * **Credit Card Charges:** Interest and fees on business credit cards. * **Business Insurance:** Premiums for professional indemnity insurance, public liability insurance, or contents insurance for your business equipment. **What is NOT allowable:** Interest on personal loans, or the capital repayment portion of any loan. **MTD ITSA Impact:** These will often be automatically captured through bank feeds if your software is integrated with your business bank account. Otherwise, bank statements and insurance policy documents should be digitally recorded and categorised under 'Bank Charges' or 'Insurance'. ### Equipment and Software The tools of your trade are crucial, and their costs are treated as capital expenditure. * **Computers, Laptops, Tablets:** Devices used for your freelance work. * **Software Licences:** Annual or one-off payments for business-specific software (e.g., Adobe Creative Suite, CAD software, project management tools, accounting software like AccountsOS). * **Cameras, Lenses, Microphones:** Specialised equipment for photographers, videographers, podcasters. * **Tools and Machinery:** Any specific tools or machinery required for your craft or service. * **Office Furniture:** Desks, chairs, filing cabinets. As mentioned, these are generally capital expenditure, meaning you claim **Capital Allowances** instead of deducting the full cost as an expense. The **Annual Investment Allowance (AIA)** is particularly beneficial, allowing you to deduct the full cost of most plant and machinery (up to £1 million) in the year of purchase. #### Worked Example: Capital Allowances (Annual Investment Allowance) **Scenario:** Sarah, a freelance photographer, buys a new professional camera for £3,000 and a new lens for £1,500 in the 2026/27 tax year. These are both 'plant and machinery'. **Calculation:** * Cost of Camera: £3,000 * Cost of Lens: £1,500 * Total Capital Expenditure: £4,500 Since the total is well within the £1 million Annual Investment Allowance (AIA), Sarah can claim the full **£4,500** as a deduction against her profits in the 2026/27 tax year. This reduces her taxable profit by the full amount of the investment, providing immediate tax relief. If Sarah had bought a larger asset (e.g., a commercial vehicle for £30,000) that also qualified for AIA, the full £30,000 could also be claimed in the year of purchase, subject to the overall AIA limit. **MTD ITSA Impact:** You must digitally record the purchase invoices for all capital assets. Your MTD-compatible software will need to correctly identify these as capital expenditure and apply the relevant capital allowances in the End of Period Statement. ### Communication Costs Staying connected is vital for most freelancers. * **Phone and Mobile Bills:** The business portion of your phone bills (landline and mobile). * **Internet Costs:** The business portion of your broadband internet bills. **MTD ITSA Impact:** Keep digital records of your phone and internet bills. If these are dual-purpose, you must consistently apply a reasonable apportionment method and record it in your software. ### Pre-Trading Expenses Even before you officially started trading, some expenses might be allowable. * **Expenses Incurred Up to 7 Years Before Trading:** You can treat expenses incurred up to 7 years before you started your business as if they were incurred on the first day of trading. These can then be claimed against your first year's profits. * **Examples:** Market research, advertising to launch your business, initial office setup costs, legal fees for setting up contracts. **MTD ITSA Impact:** You will need to digitally record these historical expenses and ensure your MTD-compatible software can correctly attribute them to your first trading year for tax purposes. ### What is NOT an Allowable Expense? Just as important as knowing what you can claim is knowing what you cannot. Claiming non-allowable expenses can lead to HMRC investigations and penalties. * **Personal Drawings:** Any money you take out of the business for your personal use is not an expense. This is simply a transfer of funds. * **Personal Living Costs:** Your personal rent or mortgage repayments (the capital portion), personal food shopping, and non-business clothing (even if you wear smart clothes for work, if they are not specifically branded workwear or protective clothing, they are not allowable). * **Fines and Penalties:** Parking fines, speeding tickets, HMRC penalties, or other legal fines are never allowable. * **Client Entertainment:** Generally, entertaining clients is not an allowable expense. There are very limited circumstances for staff entertainment, but client entertainment is almost always disallowed. * **Depreciation:** You cannot claim depreciation of assets as an expense. Instead, you claim capital allowances. * **Political Donations:** Donations to political parties are not allowable. * **Gifts (with exceptions):** Gifts to customers are generally not allowable unless they are promotional items that cost £50 or less, bear the business's name, and are not food, drink, tobacco, or vouchers. **MTD ITSA Impact:** Your MTD-compatible software should help you correctly identify and exclude non-allowable expenses from your business profit calculations. Consistent categorisation is key. ## The Importance of Digital Record Keeping for MTD ITSA Under Making Tax Digital for Income Tax Self Assessment (MTD ITSA), digital record keeping is not merely a recommendation; it is a fundamental legal requirement for eligible freelancers. This shift represents a significant move away from traditional paper-based or even basic spreadsheet accounting, embedding digital processes at the heart of tax compliance. ### Why Digital Records are Mandatory Under MTD The mandate for digital record keeping under MTD ITSA serves several critical purposes for HMRC: 1. **Ensuring Accuracy:** Digital records, especially when integrated with banking and payment platforms, reduce the likelihood of manual data entry errors. This leads to more accurate tax returns and fewer mistakes for both taxpayers and HMRC. 2. **Facilitating Quarterly Updates:** The requirement for quarterly submissions means that records must be consistently up-to-date. Digital systems are inherently better suited to capturing and summarising data on an ongoing basis than retrospective manual compilation. 3. **Creating a Digital Audit Trail:** Digital records provide a clear, traceable audit trail from individual transactions through to the summary figures submitted to HMRC. This simplifies any future queries or investigations from HMRC. 4. **Promoting Efficiency:** While there's an initial setup effort, digital record keeping can streamline business processes, saving freelancers time on administrative tasks and allowing them to focus more on their core work. 5. **Standardisation:** MTD ITSA aims to standardise how income and expenses are recorded and reported across a wide range of self-employed individuals and landlords, making the tax system more consistent. For freelancers, adopting digital record keeping proactively is not just about compliance; it's about future-proofing your business and gaining better financial insight. ### What Specific Records Must Be Kept Digitally? HMRC requires you to keep digital records of all your business income and expenses. This includes, but is not limited to: * **Sales and Income:** * Dates and amounts of all sales and other income. * Details of the nature of the income (e.g., freelance project fee, product sale). * Invoices issued to clients. * Records of cash sales (e.g., till rolls, daily summaries). * Bank statements showing income received. * **Purchases and Expenses:** * Dates and amounts of all business purchases and expenses. * Details of the nature of the expense (e.g., software subscription, travel, office supplies). * Receipts and purchase invoices. * Mileage logs for business travel (if claiming actual vehicle costs or mileage allowance). * Records of capital expenditure. * Bank statements showing payments made. * **Adjustments:** Any adjustments made for things like private use of assets or stock adjustments. * **VAT Records (if applicable):** If you are VAT registered, your VAT records must also be kept digitally. Critically, the *source data* for these records must be digital. This means scanning paper receipts or ensuring that invoices received electronically are stored digitally. Simply entering summary data into a spreadsheet without retaining the underlying digital source is unlikely to be sufficient. ### Tools for Digital Record Keeping (e.g., AccountsOS, spreadsheets with bridging software) To comply with MTD ITSA, freelancers will need to use MTD-compatible software. This broadly falls into two categories: 1. **Dedicated MTD-Compatible Accounting Software:** * Solutions like AccountsOS, Xero, QuickBooks, and FreeAgent are designed to manage all aspects of your business finances digitally. * They offer features such as bank feed integration, automated categorisation of transactions, digital receipt capture, invoice generation, and direct submission of MTD updates to HMRC. * **AccountsOS** is specifically built to simplify this process, offering real-time profit tracking, AI-powered expense categorisation, and direct MTD ITSA submission capabilities, ensuring compliance while providing financial clarity. * These solutions are generally the most robust and future-proof option, offering comprehensive financial management beyond just tax compliance. 2. **Bridging Software:** * If you currently use spreadsheets to manage your records and prefer to continue doing so, you may be able to use 'bridging software'. * This software acts as a digital link, taking the summary data from your spreadsheet and converting it into an MTD-compatible format for submission to HMRC. * While it allows you to retain your spreadsheet workflow, it requires careful management to ensure the spreadsheet itself is MTD-compliant (e.g., using formulas with digital links, not manual input for calculations). It also typically offers fewer features than dedicated accounting software. Choosing the right tool depends on the complexity of your business, your comfort with technology, and your desire for integrated financial management versus a tax-focused solution. ### How Long to Keep Digital Records The requirement for retaining records under MTD ITSA remains consistent with existing tax rules. You must keep your business records for at least **5 years after the 31 January submission deadline** following the end of the tax year they relate to. **Example:** For the tax year 2026/27, which ends on 5 April 2027, the online Self Assessment filing deadline (and the MTD Final Declaration deadline) is 31 January 2028. Therefore, you must keep your records for the 2026/27 tax year until at least **31 January 2033**. It is often prudent to keep records for longer, particularly if you have complex transactions, carry forward losses, or if there's any possibility of an HMRC enquiry. Digital storage makes long-term retention much easier and less cumbersome than paper archiving. ## Calculating Your Taxable Profit Under MTD ITSA The fundamental calculation of taxable profit remains the same under MTD ITSA: it is your gross business income minus your allowable business expenses. However, the process of arriving at this figure will be digital and more frequent. This profit figure is what your Income Tax and Class 4 National Insurance contributions will be based on. ### Gross Income Minus Allowable Expenses Your **taxable business profit** is derived directly from this simple formula: **Gross Business Income - Allowable Business Expenses = Taxable Business Profit** * **Gross Business Income:** This includes all money, goods, or services your business receives before any deductions. For most freelancers, this means all client payments, sales of products, or any other revenue generated by your freelance activities. * **Allowable Business Expenses:** These are the costs incurred 'wholly and exclusively' for your business, as detailed in the previous section. Under MTD ITSA, your MTD-compatible software will automatically perform this calculation based on the digital records you maintain. Each quarterly update will provide an estimated profit for that quarter, and the End of Period Statement will finalise the profit for the entire tax year. ### Cash Basis vs. Accruals Basis (and MTD Implications) Freelancers typically use one of two accounting methods: 1. **Cash Basis Accounting:** * You record income when you *receive* it and expenses when you *pay* them. * Most sole traders and small businesses with a turnover of **£150,000 or less** can use the cash basis. * **MTD ITSA Implications:** The cash basis is generally simpler for MTD ITSA as it aligns well with real-time bank transactions. Your software will record income and expenses as they hit or leave your bank account (or as cash changes hands). 2. **Traditional Accounting (Accruals Basis):** * You record income when you *invoice* it (or earn it), regardless of when you get paid. * You record expenses when you *incur* them (e.g., receive a bill), regardless of when you pay. * Mandatory for businesses with a turnover above £150,000, and an option for smaller businesses. * **MTD ITSA Implications:** While still compatible with MTD, the accruals basis requires tracking invoices and bills separately from cash movements, which can be slightly more complex. MTD software will manage this by distinguishing between invoice dates and payment dates. You choose your accounting method when you prepare your first MTD ITSA End of Period Statement. It is generally advisable to stick with one method for consistency. #### Worked Example: Calculating Taxable Profit with MTD in Mind Let's use a freelance web developer, David, for the 2026/27 tax year, using the cash basis. **David's Income:** * Client Project 1: £15,000 (received 10/05/2026) * Client Project 2: £8,000 (received 22/07/2026) * Client Project 3: £12,000 (received 05/11/2026) * Client Project 4: £10,000 (received 15/02/2027) * Total Gross Income: **£45,000** **David's Allowable Expenses:** * Software Subscriptions: £1,200 (paid throughout the year) * New Laptop (Capital Allowance via AIA): £1,800 (paid 01/06/2026) * Home Office Simplified Expenses (101+ hrs/month): £312 (calculated annually, but can be factored in quarterly) * Professional Development Course: £750 (paid 01/09/2026) * Internet & Mobile (business portion): £480 (paid monthly) * Accountant's Fees: £500 (paid 31/03/2027) * Business Insurance: £200 (paid 01/04/2026) * Travel to Client Sites: £350 (paid throughout the year) * Total Allowable Expenses: **£5,692** **Calculating Taxable Business Profit:** * Gross Business Income: £45,000 * Less: Total Allowable Expenses: -£5,692 * **Taxable Business Profit: £39,308** Under MTD ITSA, David's software would track these transactions digitally. At the end of each quarter, it would generate a summary of income and expenses, providing a running total of his estimated profit. For example: * **Quarter 1 (Apr-Jun 2026):** Income £15,000, Expenses (Software, Laptop, Insurance, Internet/Mobile) approx. £2,200. Estimated Profit: £12,800. * **Quarter 2 (Jul-Sep 2026):** Income £8,000, Expenses (Software, Course, Internet/Mobile) approx. £1,000. Estimated Profit: £7,000. * And so on, until the End of Period Statement where the final profit of £39,308 is confirmed. ### Dealing with Business Losses If your allowable expenses exceed your gross business income in a tax year, your business has made a loss. While you don't pay tax on a loss, it is still crucial to report it accurately in your MTD ITSA submissions. * **Loss Relief:** Business losses can often be carried forward and offset against future profits from the same business. This reduces your tax liability in subsequent profitable years. * **Carry Back:** In certain circumstances, losses can be carried back to offset against profits from previous years, potentially resulting in a tax refund. Your MTD-compatible software will help you track and report losses correctly, ensuring you can claim the appropriate loss relief when submitting your End of Period Statement. ## National Insurance Contributions (NICs) for Freelancers As a freelancer (sole trader), you are typically liable for two types of National Insurance Contributions: Class 2 and Class 4. These contributions are important for your entitlement to certain state benefits, most notably the State Pension. The rates and thresholds for NICs are subject to change, but we will use the latest available information for 2024/25, which is expected to continue into 2026/27. ### Class 2 National Insurance * **Threshold:** If your taxable profits are above the Small Profits Threshold (SPT), which is £6,725 for 2024/25. * **Rate:** From April 2024, if your profits are above the SPT, your Class 2 NI contributions are treated as paid automatically, with no actual payment required. * **Voluntary Payments:** If your profits are below the SPT, you can choose to pay Class 2 NICs voluntarily to protect your entitlement to state benefits, including the State Pension. The voluntary rate for 2024/25 is £3.45 per week. The changes from April 2024 significantly simplified Class 2 NICs for many freelancers, ensuring they build State Pension entitlement without an explicit payment, provided their profits are above the threshold. For those with lower profits, voluntary payments remain a crucial consideration. ### Class 4 National Insurance Class 4 NICs are calculated as a percentage of your taxable business profits above certain thresholds. Unlike Class 2, Class 4 contributions do not count towards your State Pension entitlement; they are essentially an additional tax on self-employment profits. * **Lower Profits Limit (LPL):** £12,570 (for 2024/25, expected 2026/27). * **Upper Profits Limit (UPL):** £50,270 (for 2024/25, expected 2026/27). **Class 4 National Insurance Rates (from April 2024, expected 2026/27):** * **6%** on profits between £12,570 and £50,270. * **2%** on profits above £50,270. These rates saw reductions in 2024, making self-employment more tax-efficient compared to previous years. #### Worked Example: National Insurance Calculation Let's use David's taxable business profit of £39,308 for the 2026/27 tax year (assuming 2024/25 rates and thresholds remain). **1. Class 2 NICs:** * David's profit (£39,308) is above the Small Profits Threshold (£6,725). * Therefore, his Class 2 NICs are treated as paid automatically, with **£0** actual payment. **2. Class 4 NICs:** * David's profit is between the Lower Profits Limit (£12,570) and the Upper Profits Limit (£50,270). * Amount subject to 6% Class 4 NICs: £39,308 - £12,570 = £26,738 * Class 4 NICs: £26,738 x 6% = **£1,604.28** **Total National Insurance for David:** * Class 2 NICs: £0 * Class 4 NICs: £1,604.28 * **Total NICs: £1,604.28** This amount will be added to David's Income Tax liability to form his total tax bill. Under MTD ITSA, your software will calculate these figures based on your reported profits. ## Income Tax Rates and Bands for Freelancers Your taxable business profit, after accounting for allowable expenses, is combined with any other taxable income you might have (e.g., employment income, rental income, dividends) to form your total taxable income. This total is then subject to UK Income Tax rates. The UK operates a progressive tax system, meaning different portions of your income are taxed at different rates. The rates and bands below apply to earnings in England, Wales, and Northern Ireland for the 2024/25 tax year, which are expected to remain the same for 2026/27. Scotland has slightly different rates and bands, which freelancers in Scotland should verify. ### Income Tax Bands (2024/25, expected 2026/27) | Band | Income | Rate | Description | | :-------------------- | :------------------- | :---- | :-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | | Personal Allowance | Up to £12,570 | 0% | This is the amount of income you can earn each tax year without paying any Income Tax. Most people are entitled to the full Personal Allowance. | | Basic Rate | £12,571 to £50,270 | 20% | This rate applies to the portion of your income that falls above your Personal Allowance and up to the basic rate threshold. | | Higher Rate | £50,271 to £125,140 | 40% | This rate applies to the portion of your income that falls above the basic rate threshold and up to the higher rate threshold. | | Additional Rate | Over £125,140 | 45% | This rate applies to the portion of your income that exceeds the additional rate threshold. | | **Personal Allowance Tapering:** Your Personal Allowance is reduced by £1 for every £2 your adjusted net income is over £100,000. This means that if your adjusted net income is £125,140 or more, your Personal Allowance is reduced to zero. | ### Worked Example: Income Tax Calculation Let's continue with David, whose taxable business profit is £39,308 for the 2026/27 tax year. Assume he has no other income and is eligible for the full Personal Allowance of £12,570. **1. Calculate Taxable Income after Personal Allowance:** * Total Taxable Income (Business Profit): £39,308 * Less: Personal Allowance: -£12,570 * **Taxable Income after PA: £26,738** **2. Apply Income Tax Rates:** * Since David's taxable income after PA (£26,738) falls within the Basic Rate band (£12,571 to £50,270), he will pay 20% on this amount. * Income Tax at Basic Rate (20% on £26,738): £26,738 x 20% = **£5,347.60** **Total Income Tax Due for David: £5,347.60** **David's Total Tax Bill for 2026/27:** * Income Tax: £5,347.60 * Total National Insurance (from previous section): £1,604.28 * **Total Tax Bill: £6,951.88** This total amount of £6,951.88 is what David will owe to HMRC for the 2026/27 tax year. MTD ITSA will provide an estimate of this liability throughout the year, allowing for better financial planning. ## Understanding Quarterly Reporting and End of Period Statements (EOPS) for MTD ITSA The shift from an annual Self Assessment tax return to quarterly reporting is arguably the most significant operational change introduced by MTD ITSA. Freelancers must adapt to a new rhythm of data submission and reconciliation throughout the tax year. ### The MTD Reporting Cycle Under MTD ITSA, the tax year (6 April to 5 April) is divided into four reporting periods. For most freelancers, these will align with calendar quarters: | Reporting Period | End Date | Deadline for Quarterly Update | | :--------------- | :------------ | :---------------------------- | | Quarter 1 | 5 July | 5 August | | Quarter 2 | 5 October | 5 November | | Quarter 3 | 5 January | 5 February | | Quarter 4 | 5 April | 5 May | Within one month and seven days of the end of each quarter, you must submit a summary of your business income and expenses to HMRC using your MTD-compatible software. ### What Goes into a Quarterly Update? Each quarterly update is a summary of your business's financial activity for that period. It will include: * **Total Income:** The gross income received by your business during the quarter. * **Total Expenses:** The total allowable expenses incurred during the quarter, broken down by HMRC's specified categories (e.g., office costs, travel, marketing, professional fees). * **Adjustments:** Any adjustments for private use of assets or other specific tax rules. Crucially, these are *summaries*. You are not sending individual transaction details to HMRC in the quarterly updates. Your MTD-compatible software will compile the categorised digital records you've kept into these summary figures. **Key Point:** The quarterly updates are for *information only*. No tax is calculated or paid at this stage, nor are any personal allowances or tax reliefs applied. Their purpose is to give HMRC a regular snapshot of your business activity and provide you with an estimated tax position. ### The Purpose of the End of Period Statement (EOPS) After the four quarterly updates for the tax year have been submitted, you will need to submit an **End of Period Statement (EOPS)** for each business or property income source. * **Finalising Business Profits/Losses:** The EOPS is where you make any final accounting adjustments and claims for capital allowances (e.g., AIA for equipment purchases) that apply to your business for the entire tax year. * **Correcting Errors:** If you discover any errors in your quarterly updates, you can correct them in the EOPS. * **Confirming Accounting Basis:** This is where you confirm whether you are using the cash basis or accruals basis of accounting for the year. * **Deadline:** The EOPS must be submitted by **31 January** following the end of the tax year. So, for the 2026/27 tax year, the EOPS deadline is 31 January 2028. ### The Final Declaration (Replacing Self Assessment) Once all your EOPS have been submitted (if you have multiple businesses or property income sources), you will then submit a **Final Declaration**. This replaces the traditional Self Assessment tax return. * **Consolidated Income:** The Final Declaration brings together all your income sources, including all business profits (from your EOPS), employment income (from your P60), rental income, savings interest, dividends, and any other taxable income. * **Personal Allowances & Reliefs:** This is where your Personal Allowance, pension contributions, gift aid donations, and any other tax reliefs are applied to calculate your final overall tax liability for the year. * **Deadline:** The Final Declaration must also be submitted by **31 January** following the end of the tax year (e.g., 31 January 2028 for the 2026/27 tax year). MTD-compatible software will manage the entire flow from digital records, through quarterly updates, to the EOPS and Final Declaration, making the process as seamless as possible. ## Making Payments on Account with MTD ITSA Payments on Account are advance payments towards your next year's Income Tax and Class 4 National Insurance bill. If your Self Assessment tax bill for a given tax year is over £1,000, and less than 80% of your tax was deducted at source (e.g., through PAYE), HMRC will typically require you to make Payments on Account. This system remains in place under MTD ITSA. ### How Payments on Account Work HMRC calculates your Payments on Account based on your previous year's tax bill. Each payment on account is usually half of your previous year's tax bill. * **First Payment:** Due by **31 January** at the same time as your balancing payment for the previous tax year. * **Second Payment:** Due by **31 July**. When you file your Final Declaration for the current tax year, you will calculate your actual tax bill. If the payments on account you made cover your actual bill, you will simply pay any remaining 'balancing payment' by the next 31 January. If your payments on account were too high, HMRC will issue a refund or credit the overpayment against future tax liabilities. ### Adjusting Payments Based on Real-Time MTD Data One of the benefits of MTD ITSA's quarterly reporting is that it provides a more up-to-date view of your business's profitability throughout the year. This can be particularly useful for managing Payments on Account. * **Reducing Payments:** If your quarterly updates indicate that your current year's profits are significantly lower than the previous year (on which your Payments on Account are based), you can apply to HMRC to reduce your Payments on Account. This can help with cash flow, as you won't be overpaying tax during the year. * **Increasing Payments (Voluntarily):** Conversely, if your profits are much higher, you might choose to voluntarily increase your payments to avoid a large balancing payment at the 31 January deadline. It is crucial to be accurate when requesting a reduction. If you reduce your payments and your actual tax bill turns out to be higher than your reduced estimate, HMRC may charge interest on the underpaid amount. #### Worked Example: Payments on Account Let's assume David's total tax bill for the 2025/26 tax year (the year *before* MTD ITSA mandate for him) was £6,500. **Payment Schedule for 2026/27 (David's first MTD ITSA year):** | Payment Type | Due Date | Amount | | :-------------------------------------------- | :------------ | :------------------------------------ | | Balancing Payment for 2025/26 | 31 January 2027 | £6,500 (his actual bill for 2025/26) | | First Payment on Account for 2026/27 | 31 January 2027 | £3,250 (50% of £6,500) | | Second Payment on Account for 2026/27 | 31 July 2027 | £3,250 (50% of £6,500) | | **Total Payments on Account for 2026/27** | | **£6,500** | So, by 31 January 2027, David would need to pay a total of £9,750 (£6,500 for his 2025/26 bill + £3,250 for his first 2026/27 payment on account). This highlights the importance of budgeting for tax throughout the year, especially with the large January payment. **Adjusting Payments with MTD Data:** If, by July 2027, David's MTD quarterly updates for 2026/27 show that his estimated total tax bill for 2026/27 is actually only £5,000 (lower than the £6,500 used for Payments on Account), he could apply to HMRC to reduce his second Payment on Account. Instead of paying £3,250, he might only need to pay £1,750 (£5,000 total bill - £3,250 already paid). This requires careful forecasting and submission of the SA303 form to HMRC. ## Key Deadlines and Penalties in the MTD ITSA Era Navigating the various deadlines is crucial for MTD ITSA compliance. Missing these can lead to automatic penalties and interest charges from HMRC. While the overall tax year and payment deadlines remain similar, MTD ITSA introduces new quarterly reporting deadlines. ### Important MTD ITSA Deadlines The UK tax year runs from 6 April to 5 April the following year. For freelancers mandated for MTD ITSA from April 2026, the key dates for the 2026/27 tax year are: | Event | Date | | :------------------------------------------ | :--------------------------------------- | | Start of 2026/27 Tax Year (MTD ITSA begins) | 6 April 2026 | | **Quarterly Updates (for 2026/27 tax year):** | | | Quarter 1 (6 April - 5 July) | Submission deadline: 5 August 2026 | | Quarter 2 (6 July - 5 October) | Submission deadline: 5 November 2026 | | Quarter 3 (6 October - 5 January) | Submission deadline: 5 February 2027 | | Quarter 4 (6 January - 5 April) | Submission deadline: 5 May 2027 | | **End of Period Statement (EOPS) for 2026/27** | Submission deadline: 31 January 2028 | | **Final Declaration for 2026/27** | Submission deadline: 31 January 2028 | | **Payments on Account for 2026/27:** | | | First Payment on Account | Payment deadline: 31 January 2027 | | Second Payment on Account | Payment deadline: 31 July 2027 | | **Balancing Payment for 2026/27** | Payment deadline: 31 January 2028 | *Note: The 5 October registration deadline for Self Assessment still applies for new sole traders, even under MTD ITSA.* ### Penalties for Non-Compliance with MTD Requirements HMRC has a penalty regime for late or inaccurate submissions and payments. Under MTD ITSA, this regime will apply to the new quarterly updates, EOPS, and Final Declaration. #### Penalties for Late Quarterly Updates / EOPS / Final Declaration While the specific penalty structure for MTD ITSA is still being finalised, it is expected to follow a points-based system for late submissions, similar to MTD for VAT. * **Points-Based System:** For each late submission (quarterly update, EOPS, or Final Declaration), you could receive a point. Once you accumulate a certain number of points within a rolling 12-month period, a financial penalty is triggered. * **Thresholds (Example, based on MTD VAT):** * Annual submissions (Final Declaration): 2 points before a penalty. * Quarterly submissions: 4 points before a penalty. * **Financial Penalty:** Typically a fixed amount (e.g., £200) for each threshold breach. The aim is to penalise persistent non-compliance rather than isolated errors. However, consistency in meeting deadlines is crucial to avoid accumulating points. #### Penalties for Late Payment The existing late payment penalty system will continue to apply to your overall tax bill: * **30 days late:** 5% of the unpaid tax. * **6 months late:** Another 5% of the unpaid tax. * **12 months late:** A further 5% of the unpaid tax. * **Interest:** HMRC also charges interest on any tax paid late, compounding daily. The interest rate is typically the Bank of England base rate plus 2.5%. #### Penalties for Inaccurate Returns If your MTD ITSA submissions (EOPS or Final Declaration) are inaccurate, HMRC can impose penalties based on the reason for the inaccuracy: * **Careless:** If you made an error but took reasonable care, the penalty can be between 0% and 30% of the unpaid tax. * **Deliberate but not concealed:** If you knew the return was inaccurate but did not try to hide it, the penalty can be between 20% and 70%. * **Deliberate and concealed:** If you intentionally tried to hide the inaccuracy, the penalty can be between 30% and 100%. HMRC may reduce penalties if you proactively inform them about an inaccuracy, cooperate with their investigation, or provide access to your records. **MTD ITSA's emphasis on digital record keeping aims to reduce inaccuracies, but it also means that any errors in your underlying digital records will flow through to your submissions. Therefore, the accuracy of your expense tracking becomes even more critical.** ## How AccountsOS Simplifies Self Assessment and MTD ITSA AccountsOS is specifically designed to empower UK freelancers and sole traders to manage their finances efficiently and comply seamlessly with Self Assessment and the upcoming Making Tax Digital for Income Tax Self Assessment (MTD ITSA) regulations. By integrating key accounting functionalities, AccountsOS transforms what can be a complex and time-consuming process into a streamlined, intuitive experience. ### Real-Time Profit Tracking One of the most significant advantages of AccountsOS is its ability to provide real-time insights into your business's financial performance. As you record income and expenses, your estimated taxable profit and potential tax liability update automatically. This eliminates the guesswork and stress often associated with year-end tax calculations, helping you: * **Avoid Surprises:** See your financial position at any moment, allowing you to budget effectively for your tax payments. * **Make Informed Decisions:** Understand the impact of your spending and earning on your profitability throughout the year. ### Expense Categorisation Accurate categorisation of expenses is critical for maximising your allowable deductions and ensuring compliance. AccountsOS simplifies this with: * **AI-Powered Categorisation:** Intelligent algorithms help to automatically categorise your transactions, learning from your past entries and bank feed data. * **HMRC-Compliant Categories:** Ensures your expenses are mapped to the correct categories required for Self Assessment and MTD ITSA reporting, reducing errors. * **Receipt Capture:** Easily upload or snap photos of your receipts, linking them directly to transactions for a robust digital audit trail. This functionality ensures you claim all legitimate deductions, thereby minimising your tax bill legally, while maintaining the digital records required for MTD ITSA. ### Deadline Reminders Missing tax deadlines can lead to penalties and interest charges. AccountsOS provides proactive support to keep you on track: * **Automatic Notifications:** Receive timely reminders for all critical Self Assessment and MTD ITSA deadlines, including: * MTD quarterly update submissions. * End of Period Statement (EOPS) deadlines. * Final Declaration submission dates. * Payments on Account due dates. * Annual Self Assessment registration deadlines. These reminders help you avoid late submission penalties and ensure you have ample time to prepare your reports and payments. ### Digital Record Keeping AccountsOS is built from the ground up to support the digital record-keeping mandates of MTD ITSA: * **Centralised Digital Hub:** Store all your invoices, receipts, bank statements, and other financial documents securely in one place. * **Bank Feed Integration:** Connect your business bank accounts to automatically import transactions, reducing manual data entry and improving accuracy. * **Compliance Assurance:** Provides a comprehensive, digitally linked audit trail from individual transactions to summary reports, essential for HMRC compliance and potential audits. By using AccountsOS, you are not just preparing for MTD ITSA; you are adopting a best-practice approach to digital financial management that benefits your business year-round. ## Frequently asked questions ### What are the main changes for freelancers under MTD ITSA from 2026? From April 2026, freelancers with gross income over £50,000 must keep digital records of their income and expenses using MTD-compatible software. They will also need to submit quarterly summaries of this data to HMRC, followed by an End of Period Statement and a Final Declaration, replacing the traditional annual Self Assessment tax return. ### What expenses are considered 'allowable' for freelancers? Allowable expenses are costs incurred 'wholly and exclusively' for your business. Common examples include office costs (rent, utilities, supplies), business travel, marketing and advertising, professional fees (accountant, legal), training related to your current trade, and business insurance. Dual-purpose expenses must be apportioned. ### Do I need to keep paper receipts for MTD ITSA? No, under MTD ITSA, you must keep digital records. This means scanning paper receipts or ensuring that invoices received electronically are stored digitally within your MTD-compatible software. The key is to have a digital audit trail for all transactions. ### How often do I need to report my expenses under MTD ITSA? Eligible freelancers will need to submit summaries of their business income and expenses to HMRC every three months (quarterly updates). These are due one month and seven days after the end of each quarter (e.g., by 5 August for the quarter ending 5 July). ### Can I still claim 'working from home' expenses under MTD ITSA? Yes, the rules for claiming working from home expenses remain the same. You can either use HMRC's simplified expenses (a flat rate based on hours worked) or calculate the actual proportion of your household bills used for business. Both methods must be supported by digital records. ### What happens if I miss an MTD ITSA quarterly reporting deadline? HMRC is expected to implement a points-based penalty system for late MTD ITSA submissions. Accumulating a certain number of points within a rolling 12-month period will trigger a financial penalty. It is crucial to submit all updates on time to avoid these charges. ### How does MTD ITSA affect my tax payments? MTD ITSA doesn't change when you pay your tax (31 January and 31 July for payments on account, and 31 January for balancing payments). However, the quarterly updates provide a more real-time estimate of your tax liability, potentially allowing you to adjust your payments on account if your income changes significantly. ### Can I use a spreadsheet for my records under MTD ITSA? You can use a spreadsheet, but it must be digitally linked to HMRC's MTD system using 'bridging software'. The spreadsheet itself must also adhere to MTD rules, ensuring digital integrity and links between data entries and calculations. For comprehensive financial management, dedicated MTD-compatible accounting software is generally recommended. ## Related guides - /tools/self-assessment-calculator - /expenses/allowable-self-employment - /filing/making-tax-digital-itsa - /deadlines