Whatever Moira Stewart might say in those silly “tax doesn’t have to
be taxing” adverts, the UK tax system is complex, confusing and
completely unfair to contractors.
In this post I will recap how basic income tax and PAYE works and then
explain how it works for contractors using an umbrella company like I
Anyone thinking about becoming a contractor will need to get their
he’d around this in much more detail than I’m covering here – this is
just establishing common ground with all readers so that you can
understand the bombshells that make contracting a bit less lucrative.
And don’t forget, this is a dramatic oversimplification.
Gross Annual Income
Minus Personal Allowance
Equals Taxable Income
Minus (20% of first ??37,400 of taxable income)
Minus (40% of taxable income between ??37,401 and ??150,000)
Minus (50% of taxable income above ??150,000)
Minus employees’ National Insurance (more complex but reasonable rule
of thumb is 12% of taxable income)
EQUALS net income.
Pay as You Earn
Gross Income for the month
Minus (one twelfth of personal allowance)
Equals Taxable Income for the month
Minus employees’ National Insurance
Minus income tax (same rates as above, to one twelfth of the limits)
Equal net pay for the month.
Employers also have to pay a different type of National Insurance
which is currently 12.8% of gross income above ???110? per week.
One way or another, if you’re a contractor, you have to pay that too.
The only good news is that this amount reduces the gross income for
tax purposes, and allowable expenses come off before all taxes and NI.
So for a contractor the calculations are:
Gross income from client
Minus umbrella company fees
Minus employers’ NI
EQUALS taxable income
That minus income tax and employees’ NI
EQUALS take-home pay.
Do those sums and you’ll see that a contractor is taxed more heavily,
and you wouldn’t necessarily be quite as well off as you might think.
Also, watch out for umbrella companies pulling the wool over your eyes
about expenses. If you spend money, it’s got to come from somewhere,
and that somewhere is your gross income from the client. Since it
reduces the tax you pay, it “costs” you less than it otherwise would –
roughly, I I spend ??100 on accomodation, that is ??60 that won’t be
going in my pocket – but the umbrellas like to make you think that
expenses are reimbursed 100% as they would be for a regular employee
of a company.
So, with all this extra tax, surely there must be a better way? There
is, and that’s running your own company, not using an umbrella, paying
yourself a minimum-wage salary (and that’s all you pay standard income
tax and NI upon) and paying the remainder as shareholder dividends.
Unfortunately a specific piece of legislation usually referred to as
IR35 prevents that for many (most?) contractors.
If you think of contractors as highly-paid all-year-round employees,
then yes, IR35 and the extra employers NI are perfectly fair. But this
gives no consideration to the risks we run looking for contracts, the
potential for being “on the bench” for months at a time, and the lack
of employee benefits (we don’t get holiday or sick pay, remember!).
Taken from that perspective, it’s grossly unfair. E
Before the election, the Tories promised to look into this issue. That
didn’t affect my voting decision, but now it’s all over… I won’t be
holding my breath for the abolition of IR35.
Next post: some technical details about my experiments with node.js
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