Member Article

Top 12 Expert Tax Planning Tips for Contractors in 2018

“The hardest thing in the world to understand is the income tax.” – Albert Einstein As the words of Albert Einstein echo, just hearing the word ‘tax’ may leave a person confused. Contractors have always been a significant part of the UK workforce. The United Kingdom has in fact, always provided a platform and environment encouraging business professionals to flourish. In the recent decades, these independent business people have been given the label of contractors. Being a contractor is indeed one of the most rewarding ways of making a living.

A significant point to analyze and comprehend from the taxation point of view is that UK contractors are not employees who are in work with a client rather, they have a time-based contract, specific projects to work on and agreed rates of payment. The contract is usually between the client and the contractor.

If you have been building a ‘pot of cash’ and enjoying all the benefits as a contractor, it is equally important to explore the tax implications. Without adequate planning, you may end up getting stuck with an unexpected tax bill. Skilful tax planning, on the other hand, can completely transform your finances. Once you get the tax planning right, you can create an excellent work-life balance that may make people around you envious. With the dawn of new year and a completely brand new tax season, it is crucial to have an in-depth understanding of the tax deductions that you as an independent business owner qualify. This helps you to maintain detailed records of invoices and receipts as a proof for utilizing these at a time when you file your deductions.

To assist you out, we put together some of the helpful tips that can help you to save tax transform your finances:

1. Create a Business Bank Account Having a separate bank account may apparently seem to be something that doesn’t apply to you as a contractor. When you have a separate business account, you can clearly calculate what money is coming for your business and how much cash you are exactly spending. On the contrary, when you carry out all the business transactions through a personal account, figuring out the exact amount used and received in business may turn out to be a cumbersome task. You may rather end up sifting through your grocery expenditures in a supermarket and find out the business related transactions. A business bank account will assist you to calculate your income and expenses accurately without consuming much of your time.

2. Set Up as a ’Limited Company’ Though it may sound obvious this is however, a significant step that a contractor must adopt to maximise the disposable income (legally). A Ltd Co. is a separate entity and is governed by the Companies Act 2006. Though there may crop up additional responsibilities and administrative requirements, with a Ltd Co. tag, a contractor may end up saving a huge amount when compared to being self-employed or being an umbrella company.

The main tax planning flexibility to decide on how much to pay hasn’t changed for Ltd. company contractors in the year 2017. As contractors, it is ultimately you who have the flexibility to decide on the exact amount of tax you pay by increasing or decreasing the dividends.

3. Pay a (Minimal) Director Salary to Yourself

Due to a change in the employment allowance last year, there are mainly two scenarios for optimum salary levels. The two levels include: • £11,500, if there is more than one employee in the company. Having more than one employee also means that you can easily claim the employment allowance. • £8,164, if the director is the sole employee. Corporation tax relief is also available on the salary.

4. Make Correct Extraction of Dividends

Dividends are primary tools for contractors who wish to extract money out of their Ltd Co’s. Contractors need to understand that timing the dividend extraction can turn out to be a useful procedure to save tax. With the increase in higher tax rate threshold, net dividends can be extracted from the company before hitting 32.5% tax rate. The maximum amount of dividends each year will include: • If on a salary of £8,164 per year, the optimum amount extracted would be £36,840 per year. • If the salary is £11,500 per year, the maximum amount extracted would be £33,480 per year.

5. Utilize the Money Saved Within the Company In order to make maximum benefits of the money saved within the company, here are a few options: • Investing in shares, bonds, and properties in name of the company can offer tax benefits. Additionally, there are innumerable life-insurance products in the market that provide immense tax benefits. • One of the most popular disadvantages of working as a limited company is lack of benefits such as a pension scheme. As a director, it is always beneficial to contribute in a pension scheme. In such a company, there is a two-fold tax-relief where the company also receives a tax relief at around 20%, this is also known as Corporation Tax. A pension scheme will not only save for retirement but is definitely a tax efficient way for extracting profits from a company.

6. Organize Occasional Staff Parties Every year, a company can pay for a staff party, and also claim corporation tax. However, this only applies to a limited company, so you can choose to simply pay for a staff party and save 40% of the cost, especially if you are a high tax payer.

7. Pay Dividends to a Spouse Under the latest tax system, the first £5,000 of dividends remains tax free despite the level of income you have elsewhere. Thus, paying dividends to a spouse who had been previously earning a higher rate threshold and not earning dividends from your company, you can receive £5,000 tax benefit. In the budget announced in Spring 2017, there lies a possibility that tax-free allowance could be reduced to £2,000 from April 2018.

8. Submit Your Data on Time If you want save on tax, an important instruction is to submit your documents and returns on time. When you submit your data or returns late, you may end up paying unnecessary fines from Companies House and HMRC. Make sure that you provide your accountant or Companies House with correct data, only then you can expect to get what you put in.

9. Avail Entrepreneur’s Relief An entrepreneur’s relief is available to contractors who close down their Ltd Co’s. Once you have utilized the director salary, dividends, and other tax-efficient means, entrepreneur’s relief can easily be applied to the funds remaining in the company. This, however, is subject to the host of criterias being satisfied. For a better understanding on this, it is advisable to contact a professional taxation service provider who has a thorough knowledge of the processes and helps you to come up with an adequate solution!

10. Make Sure that you Comply with IR35 Rules IR35 is a legislation tax that assesses contractors on the basis of their respective working arrangements. If your company is caught in the IR35, it can defeat the object of running a contractor or freelancer business through the Ltd Co. IR35.

As per the changes made in April 2017, contractors who are working in the public sector will no longer have a say in their IR35 status. Instead, the IR35 status will entirely be determined by the public sector body.

11. Maintain and Record the Data Exactly recording what money has come in your business and how much you’ve paid can turn out to be an utterly burdensome task, especially if a few weeks slide by. It is therefore, important to take out some time to add in your invoices. Data such as paid amount and outstanding amount needs to be recorded. Keeping all the records updated means that it lowers the stress-level, especially when you submit your self-assessment.

12. Claim on Capital Assets When you buy capital assets such as hardware, laptops, fixtures and furnitures for your office, you can always claim a capital allowance in the first year of purchase. Precisely, this is an accelerated depreciation charge that helps in providing tax relief in the first year of purchase. The amount of allowance however, keeps altering in the budget every year! A Note of Advice: Well, for trusted results, it is always a better decision to hire a comprehensive accountancy and taxation service provider that eliminates the ‘hassle-factor’ in saving tax and running a company smoothly. As a contractor, it is vital that your business runs efficiently. Make the most of the tax breaks available and stay safe.

The Bottom Line There are multiple tax benefits of being an independent contractor. All you need to do is make a thorough research when estimating the tax burden in future. As discussed above, suitable planning of tax with a pro is one of the most trusted ways of minimizing tax liability. While utilizing a tax preparer may appear to be an added expense, however, the beneficial part is, you can always add the payment you’ve made to them on the business portion your taxes.

This was posted in Bdaily's Members' News section by Vidit Agarwal .