Contractors and Freelancers: How Should You Pay Yourself?

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May 03, 2016
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The freedom of working for yourself is pretty unrivalled when it comes to making a living. Somewhat erratic wages are a natural by-product of working around clients who have their own schedules and priorities, and freelancing means you’ll have to weather the peaks and troughs to achieve self-sufficiency.

What can be difficult is knowing how much to take from your gross earnings, and how to declare them for tax purposes. Do you carry on as a sole trader, or incorporate your business to become more tax efficient? Let’s look at how you should pay yourself to minimise your tax bill and maximise financial security.

Going It Alone

Sole traders face a basic tax rate of 20% up to the threshold of £43,000 per annum. This includes a personal allowance of £11,000, meaning the remaining (potential) £32,000 of taxable income is liable for a 20% slice of the pie. Above this, tax rates jump to 40%.

Your taxable income determines how much you owe after fixed costs, overheads and tax relief are taken into account, which makes it crucial to stay on top of your incomings and outgoings to ensure you have enough to pay yourself and your tax. There’s plenty of great accounting software out there for freelancers and contractors to streamline their bookkeeping.

It’s wise to establish a regular wage for yourself, rather than treating your business bank account as a pot to dip in and out of. Bear in mind that cash flow issues can be avoided by withdrawing the same amount each month, regardless of whether your profits have shot up or down. This will give you more long-term security and provide ample room to invest in growth when the time calls for it.

Paying Dividends

Whilst setting up as a sole trader is extremely simple, many contractors and freelancers incorporate their businesses in the long run, to become more tax efficient. As the owner of a limited company you’re also a shareholder, meaning you can be more flexible in the way you withdraw your profits.

Limited company owners can withdraw their profits in two ways – as a salary, and as dividends. As with sole traders, your salary is subject to 20% income tax after £11,000, whereas dividends are taxed at a much lower rate of just 7.5%.

With this in mind, the most tax-efficient way to pay yourself operating under a limited company, is to pay yourself an annual salary under the £11,000 personal allowance, and withdraw the rest as dividends. Furthermore, as dividends are subject to a £5,000 allowance, you can make savings here too.

Getting to grips with freelancing and contracting can be difficult at first, but with the help of a specialist accountancy firm (that’s us!), you can get your head around tax implications and understand how best to pay yourself.

Looking for expert advice on taxation and take home pay? Bright Ideas Accountancy can help with all of your accounting needs. Call us on 0161 669 4221, or email Info@biaccountancy.com for a quote.

 

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