Independent contractor – company and personal taxes
When you become contractor and start your limited company you’ll face quite a lot of challenges and you’ll have more responsibilities – paying taxes is one of them.
To avoid legal issues, fines and too much stress you should always keep your finances in order. First prepare and learn everything about what taxes you are required to pay, make clear payment schedule and follow few simple practices to make your tax time stress free.
You can either do this yourself or hire a great accountant.
If you go umbrella service then they should be doing all this for you at source each week or month.
Pay on time
There are monthly, quarterly and yearly payments for different taxes. Make a schedule and pay each when the time comes. Make efficient reminders and always pay on time it will help you
It will reduce significant amount you’ll have to pay at the end of year.
Organize your records
Learn everything you can about taxes, be organized and keep track of your payments. It will be much easier for you to estimate next year incomes if you keep records of previous years.
Make it a habit to keep all receipts, to document expenses, and file any tax-related paperwork or documents as you could get significant tax deductions.
If you make an organized system you will always be prepared, never late and ready for changes.
There are numerous different taxes, both you will pay as a company and personally.
Even if you decide to hire accountant the best solution is to learn as much as you can about taxes, as it will cut off the stress and make you feel more confident, and you’ll be able to manage your company to your advantage.
But this is possible only if your contracts are out of IR35 legislation. If your contract is caught by IR35, you will pay higher taxes, so you should try to remain outside the IR35 if you can. From April 2021 this may not be possible.
1. Corporation tax
The most important tax obligation that applies to limited companies is Corporation Tax. This tax is for annual profits of all companies. The profit of your company is the money that is left over from company’s turnover after you’ve deducted your business expenses, including your salary.
You will have to register your company with HMRC within 3 months of starting trading.
Current Corporation tax rate is 19%, it remains to be seen what happens in a post Covid-19 economy.
It is calculated and paid annually, based on your ‘Corporation Tax accounting period’ – the notification about your Corporation Tax accounting period, along with the relevant submission and settlement deadlines will be sent to you by HMRC.
You are obligated to pay the previous year’s tax within 9 months of your company year-end date. The deadline for submitting associated Company Tax Return is 12 months from the end of your accounting period.
Contractors whose companies are under the IR35 will pay themselves salary, which will include the most of annual profit and their Corporation Tax obligation will be very small.
2. Value Added Tax
Majority of contracting companies is registered for VAT. You will have possibility to register for standard VAT scheme, or the Flat Rate scheme.
If you expect that you’ll reclaim small amounts of expenses, Flat Rate scheme could be better solution.
Standard VAT scheme means that you’ll have to account each transaction and Flat Rate you apply a flat percentage to your turnover – which is 14.5% for most contractors and 13.5% in the first year of joining the scheme.
You will have to complete a Vat return each quarter and submit it with payment within one month of the end of the quarterly period.
3. Employers’ National Insurance
Limited companies pay Class 1 NICs on the salaries paid to their employees.
Your company is your employer, and is obligated to pay 13.8% on the salary above £162 per week.
However, if your company meets certain requirements you can reclaim up to £3,000 of Employers’ NICs each year, thanks to the Employment Allowance.
Many contractors, whose contracts are not caught by IR35 draw low salaries, and avoid Employer’s National Insurance
If your contract is caught by IR35, your salary will be higher and the amount of Employer’s National Insurance will be significantly higher.
Employer’s National Insurance is paid monthly.
Besides your company’s obligations, you’ll have few personal taxes to consider.
i. National Insurance
Employees, which includes limited company directors, also pay Class 1 NICs on their earnings. The rates are 12% between £162 and £892 per week, and 2% on earnings above £892 per week.
If your contract is caught by IR35, Employee’s National Insurance contributions on your salary will be high.
If your contract is not caught by IR35, then National Insurance contributions will be small if any, since your pay will be low, and the most of your income will be taken by dividends.
Employee’s National Insurance Contributions are paid monthly.
ii. Income Tax
As a limited company director, you will have to pay standard PAYE – Pay as your Earn taxation, for any salary you draw.
Income tax will be paid on any income received above the personal allowance threshold, which is £11,850 in 2018/19.
The higher income you receive the higher rate you’ll have to pay – 20% – basic rate, 40% – higher rate and 45% – additional rate.
Here there is also great difference whether your contract is caught by IR35 or not. If it is, your entire company income will be subject to PAYE.
If not, only small amount of your income, through your low salary will be deducted through PAYE. In this case, you will receive dividends, which are subject of different tax.
Income Tax is paid monthly.
iii. Dividend Tax
If you are not caught by IR35, you will draw most of the profit from your company in the form of dividends.
Dividends are payments made to the owners of a company, in the case of your limited company this is you.
Dividends are not tax free as they are sort of income, but they are taxed at lower rate than standard income. They are also free of National Insurance.
Dividends are paid out of company’s money left after you’ve paid Corporation Tax. Because that income has already been taxed, it cannot be taxed twice.
Other taxes you may come across while contracting include Capital Gains Tax (if you realize a profit on any investments, including if you sell your company at some time in the future
iv. Capital Gains Tax
You can come across this tax if you decide to close or sell company and make capital distribution to yourself or if you get profit on any investment you’ve made.
You should always get consultations with accountant about an important thing as taxes. But the more you learn yourself about it, the better you will manage your finances, make financial plans and save yourself from additional stress.
Note: The above is intended as a guide. Please seek professional advice from a suitably qualified and experienced account or HMRC.