Increasing your take home pay when you have a fixed contract with a client is much simpler than it seems at first glance. By calculating the most tax efficient way of structuring your income, you could save thousands of pounds.
If you are contracting services via an umbrella company, you are effectively a Pay-As-You-Earn employee and so you have fewer options.
If you set up your own limited company, there are several ways of significantly reducing your tax burden. ContractingWISE works with some excellent accountancy firms who can help you with a contractor salary calculator to show what level of savings you could achieve. Here’s how they do it.
Using a limited company – salary and dividends
By having your fees paid to your own limited company, you can save tax by drawing some of your pay as dividends, topped up by a small salary.
Dividends are not subject to National Insurance Contributions (NICs), so it makes sense to use dividends for a large chunk of your take home pay.
You can also make use of the benefits of the lower end of the income tax scale by using your tax free allowance.
Structuring your company
So you’ve set up a limited company and your fees are paid into a limited company. After deductions – expenses, fees, and corporation tax at 20 percent – you should be left with a profit.
But the profit belongs to the company – a separate legal entity. To draw it down, you need to pay yourself dividends.
Dividends are subject to basic rate, higher rate and additional rate tax, just like income tax – but the rates you pay are lower. At the moment, the basic rate for a contractor’s limited company is effectively zero, while the higher rate adds up to 25 percent.
There are several advantages to dividends – you can decide when to take a dividend which means that you can leave money in the company rather than tip into the higher rate tax bracket, and perhaps draw down the money in the future.
And if you are married or have a civil partner, they can also make use of their basic rate of tax in a practice known as ‘income shifting’.
Salaries are also a useful way of structuring your tax affairs. Because salaries are deductible from a company’s corporation tax bill, you can make use of your tax free allowance – something that doesn’t apply to corporation tax or dividends.
So, by balancing your salary and dividends, you can make use of your tax bands and tax free allowance that can add up to a big saving. For someone charging £300 a day, some accountants say they can save as much as £10,000 a year in tax.
For more advice and ideas on how to maximise your income, contact us – ContractingWISE works with trusted companies who can help you make the most of your tax options.