Contractor’s annual health check
What you need to know NOW to maximise your take home pay
Guide for freelancers and contractors: Annual health check – getting your affairs in order
You’ll get the most from your contracting career by accepting that you are responsible for your personal and company financial affairs. Keeping yourself ahead of this monetary game is the key to peace of mind and an easier life. It only requires a small investment of time and a dash of discipline.
This e-brief has been prepared specifically for contractors and freelancers and looks at the steps you can take, at least annually, to maintain a healthy personal and company financial profile. Anytime is a good time to check your company affairs are in order and set up to ensure you get the best, and the most, from contracting. If you’re new to contracting you’ll want to make sure you get off to a good start and set up your company in the best way. If you’ve been contracting a while it’s a good idea to revisit your company set up and ensure it’s running in the most tax efficient way. The start of the 2016/17 tax year saw government introduce some big changes that directly impact Umbrella workers, which means, is you are contracting through an Umbrella now is a good time to review whether this is still best for you.
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Of course, working with a specialist contractor accountant will certainly make life easier and the return you will get for the monthly investment will soon pay off. If you’re ready to receive expert advice from a Personal Accountant dedicated to you, give Intouch Accounting a call on 01202 901 385 or email firstname.lastname@example.org
Contractor’s annual health check : What you need to know NOW to maximise your take home pay
The key annual check is to reconsider your financial needs and create your own income plan. It’s the focal point of your finances. Your plan should start off by estimating what you need, in cash terms, to meet your day to day living costs, together with those little luxuries that commonly become necessities, such as fast cars, long holidays and the toys that make life more fun…or it may be things for your children!
If you have savings you want to use then you can deduct the amount of savings – these are net of tax and a simple deduction. You can also deduct financial contributions received from other members of the household. The balance is the amount you need to generate personally. Having worked out your cash need it’s time to assess what that means in terms of pre-tax, gross earnings required from your company and other sources.
The next step is to consider how you will take money from the company
Getting the most out of the tax year
Your income from the company will be subject to tax. Getting the most from what you take is important and that means a decision between salary and dividends, but only once you have checked that you are not subject to IR35.
Dividend / salary split
Provided you remain outside of IR35 you will continue to have the flexibility to decide on the split between a salary and the dividends taken to contribute towards your income plan. We look closely at your choices of salary versus dividends within the company part of this e-brief.
Dividend nil rate
Regardless of the level of your personal income, the first £5,000 of dividends are tax free. If you receive dividends from companies other than your own remember to take those into account. The £5,000 is not additional personal allowance or an increase in tax bands – it is simply a rate of 0% tax on that part of income.
Make use of your basic rate band
Generally, contractors should make sure they make the most of the basic rate income tax band, made up partly of salary, dividends when outside IR35 and other income from savings and investments.
From 6 April 2016 interest on savings and investments is received gross. Basic rate tax is no longer deducted and paid directly to HMRC before interest is paid to you. Remember to consider the gross amount of other income when assessing your income plan above. If you are a basic rate taxpayer, then your first £1,000 of interest is tax free. This is reduced to £500 for a higher rate taxpayer and lost once your taxable income exceeds £150,000.
Use our free dividends calculator to work out how much tax you’ll have to pay during 2016/17 according to the new dividend taxes.
Other considerations affecting your income plan
If you have one or more children under the age of 16, or over 16 but still in full-time education, you are entitled to Child Benefit. However, there is a tax charge where one of the parents or guardians earns over £50,000. The higher income tax charge is payable by those earning over £50,000, regardless of whether they are the recipient of the Child Benefit payments.
The level of income determines when and how much is repayable for any student loans. There are different types of student loan, with different rules affecting the timing and amount of payment that will be taken from you. Careful planning of your income needs should take into account the repayments that arise from the required level of income.
You are entitled to make £3,000 tax free gifts as an annual allowance for IHT and small gifts made out of income. If you support family with cash gifts, don’t forget to add these to your income plan.
Are you claiming all the business expenses that you personally incur from the company? If you have incurred expenses personally on behalf of the company, ensure you reclaim this expenditure to replenish your personal cash needs. The amounts recovered are not taxable provided that the expenditure is a genuine business expense.
If you have young children and rely on nursery care, have you considered the use of child care vouchers paid for by your company? Having your company meet these costs will reduce your cash needs and therefore the income you need to take.
Digital tax account
Do you have any tax arrears? If you do they need to be built into your calculations.
If you have not already done so, sign up to create a digital tax account with HMRC – this will give you visibility of your personal tax situation. You can check that HMRC holds the correct details for your:
Your tax code determines the amount of free pay before income tax starts. It may reflect adjustments made by HMRC that are inaccurate or alternatively may not reflect all the necessary changes. Having the wrong tax code means that you may underpay tax and this would add to your cash needs later. It takes only a few minutes to check your tax code and this can be corrected very easily.
Personal tax liabilities
As your tax return is submitted after the tax yearend, any shortfall in the tax paid during the year will need to be paid in January and you may also have personal payments on account in both January and July. Check your digital account to make sure that you have included any tax payments within your personal income plan. If you are due a refund, you can claim this quickly via the tax account
National Insurance Contribution (NIC) record
Take the time to also look at your NIC record. It’s accessible within your digital tax account and you will be able to decide if your record is sufficient for state pension purposes.
Investment review / financial services
You should regularly review your savings and investments. Having an (IFA) independent financial adviser is always a good idea and they will often undertake this task for you.
Capital Gains Tax (CGT) allowance
Everyone is entitled to make tax free capital gains of £11,100 per annum. If you intend to sell any assets consider the right time to do so and make maximum use of your annual allowance when you do.
Protecting your assets
Don’t forget to protect what you have earned or created from your hard work. Always make sure that you are properly insured and that your assets are protected. However, too often contractors forget to consider protecting their ability to work in the first place. Sickness, health cover and life insurance are important issues that should be in place to deal with unforeseen health issues that could restrict your ability to work.
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Setting up your company in the right way should be a priority and there is no single answer that is best for every contractor. It’s often too easy to set up a company at the beginning but forget to review this regularly, especially where your personal circumstances change.
Here are a few areas to consider that will help in getting the most from your company and to ensure your income plan can be met by the company in the most tax effective way.
Dividends are paid to shareholders in the proportions that the shares are held. This means that you can’t simply pay shareholders any amount. Properly structured companies with more than one shareholder should consider creating different classes of shares. In the right circumstances, especially with husband and wife shareholdings, this will enable your company to pay dividends in varying proportions that best suit the tax position of both yourself and your spouse.
Always consider IR35 throughout the tax year. It’s very easy to think having a review at the beginning of a new contract is all that’s needed. But, contracts often are extended, sometimes several times, and it’s not unusual for the duration to exceed a year, or even more. During this time the working practices evolve and will likely change such that your IR35 status becomes more at risk.
Undertaking several IR35 reviews during the life of the contract will protect you from straying into a riskier arrangement with your client. We recommend this to be undertaken whenever a contract is extended or at least every 12 months for long contract periods.
When your company pays a salary it will gain tax relief on the cost. However, salaries may suffer either employee’s National Insurance (NI) or both employee’s and employer’s NI.
Employee’s NI is 12% initially and the additional company cost of employer’s NI is calculated at 13.8%. The combined additional tax of 25.8% is a serious additional tax cost that can be managed by careful selection of the right level of salary
Selecting the best salary requires an understanding of the overall tax cost, not just personally, but also having regard to the tax relief gained by the company. Your accountant will be able to provide the necessary guidance, but if their answer is simply to consider the NI threshold, you may not be getting the best advice.
If your spouse (or partner) has income too low to make full use of their personal allowance a salary paid to them would help contribute towards an income plan. Spouse’s wages should reflect the level of work they do for the company and it’s not uncommon for salaries up to the personal allowance to be considered.
Having a second employee would mean that you are able to consider the Employment Allowance when looking at the right salary / dividend mix.
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Your company is entitled to reduce its employer’s NI cost by up to a maximum of £3,000 provided that it does not only employ its director. This is called the Employment Allowance. To qualify the company must pay a salary to a second employee, which may be your spouse, or partner. However, there are pitfalls and your accountant can give further guidance on this.
With the introduction of auto enrolment of employees into a pension scheme having a second employee may mean that your company is not automatically exempted.
Talk to your accountant or an IFA to establish if you should be operating a pension scheme and, if so, have considered whether opting in or out is right for you and your employees.
Pension contributions are an important part of your future income plans. It doesn’t matter your age; you should be aware of the need to save for your retirement. A financial advisor will recommend the best solution where a pension is required.
Your company incurs tax on its profits and claiming relief for business expenses is the simplest measure to keep tax to a minimum. Always make sure that any expenses incurred, personally on behalf of the company, or by the company itself, are fully claimed. It’s all too easy to disregard small costs, but their frequency often means that they add up to a more serious amount.
Travel and subsistence is often the largest single cost category. Using benchmark scale rates is a good idea however be cautious as new rules from April 2016 mean that many such claims will be dismissed by HMRC if they are not subject to a proper checking system
Flat Rate percentage
The selection of the Flat Rate Scheme and the industry sector is very important. Recent tax rulings suggest that many people have selected inappropriate categories and you may be paying the wrong amount of VAT to HMRC.
Reconsider your selected category, using the dictionary understanding of the words used in the HMRC categories. Where a category does not exist but that applies to you, you may be entitled to use one of the “not listed elsewhere” category and lower the rate you are paying. You may even be entitled to make a back claim for overpaid VAT.
Accumulated wealth and exit
Recent changes in the taxation of capital distributions on a winding up became effective on 6 April 2016. If you were planning to liquidate your company in the future to realise the surplus income accumulated, and intend to continue working or contracting, you must consider that the distribution will be taxable as a dividend.
Investing the surplus profit
Many contractors accumulate surplus income within their company. You should invest that money wisely to get the most from it, having regard to capital appreciation as well as income. We always recommend that proper advice is taken before ever considering an investment strategy. An IFA should be able to help guide you based on your risk preference and your need for capital or income.
Your company should protect itself as well as its key worker: you. The common insurance policies taken out cover sickness and health. Certain life policies can be paid by the company without incurring tax on the personal benefit. Again an independent financial advisor can provide the guidance on what’s right for you.
If your contract requires professional indemnity, then your company should have a policy in place. It is a sensible idea, in any case, to consider all risks to your company and have the necessary insurance to protect itself.
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