What should contractors pay themselves?

What should contractors pay themselves?

16 September 2017

Contractor pay is important to us. Many contractors work long hours and have to perform a lot of additional administration that isn’t involved in other lines of work. So it is important that the financial rewards match the burdens of the job.

Unfortunately, the tax framework for contractors is something of a minefield. Recognising the most efficient way to draw income from your contracts is far from simple.

Between umbrella contracting, dividends and IR35 legislation, it can be difficult to know the best way of doing things. We hope to clear it up in this blog post.

Employed by an umbrella company

If you operate through an umbrella company then you pay tax via a standard PAYE income tax formula – just as you would if you were an employee of a normal company.

Umbrella companies take the hassle out of getting paid for contracts. They cut out a lot of the administrative work and stop the tax efficiency limbo that many contractors play with HMRC.

Umbrella schemes have become more popular recently, particularly in light of the public sector IR35 changes which prompted many public sector contractors to make the switch from personal service companies to try and address some of the loss in income.

Some umbrella companies charge different rates and some offer extra perks, but all legally compliant umbrella companies offer fundamentally the same service and give contractors similar rates of income.

Operating through a limited company

If you are a limited company contractor, then you have more control over what and how you pay yourself.

Contractors who fall outside the realms of IR35 usually pay themselves through a mixture of dividends and a small salary. The dividend tax-free allowance has been brought down to £5,000 in recent years and will fall again to £2,000 in April 2018, but dividends will remain a tax efficient way to draw income from your limited company.

Dividends are not subject to National Insurance Contributions (NICs) like salaried income is, so even though contractors stand to lose a few hundred pounds from the dividend allowance cut, they can still save money relative to salaried employees.

For more detailed advice on how to efficiently balance your taxable income and dividends, please contact a member of the accounts team. Call: 0800 121 6513.

Caught by IR35

With changes to the way the rules are applied in the public sector, more and more contracts are being determined as ‘inside IR35’. In the eyes of HMRC, this means that the work is actually ‘disguised employment’ and so the contractor is required to be taxed as if they were a PAYE employee.

In most ‘inside IR35’ circumstances it is more tax efficient for the contractor to operate through an umbrella company, rather than a limited company. Umbrella company workers will still earn as if they are PAYE employees, but will also get access to additional benefits such as holiday and sick pay.

Matt Watts, Business Development Manager at Umbrella.co.uk said: "With the government looking determined to crack down further on false employment, many experts believe that umbrella companies will become even more popular in years to come."

For more advice on contractor payments, speak to a member of the accounts team today. Call: 0800 121 6513.