It sounds great, being your own boss. But before you head out on your own make sure you take time to research exactly what it means for your finances, as well as your work-life balance.
In this iContract podcast, Mark Beal-Preston, Managing Director of First Freelance, an FCSA Accredited accountancy firm geared specifically to freelancers and contractors, shares helpful tips for those getting started.
“If you are thinking about becoming your own boss as a contractor or freelancer, it is important you understand your working options and get your business structure right from the start,’’ he advises.
“Most contractors choose to set up either as a sole trader or limited company. But if you’re going into business with others, you might set up as a partnership or limited liability partnership.’’
“All options come with their own advantages and considerations, so it’s important you understand the different options and associated tax implications before deciding on your preferred way of operating,’’ says Mark.
“Subject to the IR35 rules, contractors who choose to set up their own limited company have greater flexibility over the timing and amount they withdraw from their company. Many directors choose to take money out of their company as a low salary, usually set at the Primary NI threshold, and the remainder as dividends, to maximise their tax efficiency,’’ Mark explains.
“Sole traders on the other hand must pay income tax and NI above the prevailing thresholds on all profits they make within the tax year. This consists of a flat-rate Class 2 NI contribution payable each week and a further Class 4 NI contributions payable through Self-Assessment.’’
Working options for freelance contractors
But Mark says you need to consider more than just your tax bill when deciding which business structure is right for you as a contractor. You should also be looking at your personal circumstances; your sector, your rates, the average length of contract, your career intentions and your employment status (IR35), amongst others.
Importantly, you also need to factor in your attitude towards risks and responsibilities. For example, are you willing to accept the responsibilities of being a director and the legal requirements that go along with it? Are you financially disciplined enough to set aside the money to pay your tax, insurance and other bills when they fall due?
As well as that, you need to look at your administration skills. Do you know how to manage your finances accurately and efficiently, or would you be better off hiring a specialist to take care of it for you so that you can focus on your projects?
Some contractors find it a better fit for their lifestyle to go on the employer’s payroll, where PAYE is taken care of, or to go through an umbrella company that manages all the administration and tax for them.
“If you source work or projects with the help of a recruitment firm you can also operate directly through the Agency on their payroll under what is known as Agency PAYE or as the employee of an Umbrella Company,’’ Mark explains.
Others who run their own limited company hire an accountant to do anything from filing their quarterly or annual tax bills, to helping plan their business and personal finances.
Mark urges contractors to check an accountant’s accreditations and also their area of expertise – you need someone who understands exactly how contractors and small businesses operate and who specialises in the tax and legal framework affecting them. Importantly, you should also choose an accountant who is working hard to help you make the most of your hard-earned money.
“Any good accountant should be proactive about saving you money,” he says.
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For people going freelance for the first time, what are the different options for freelancers?
If you are thinking about becoming your own boss as a contractor or freelancer, it is important you understand your working options and get your business structure right from the start!
The most common ways of running your own business are usually as a sole trader or setting up and running your own Limited Company.
If you go into business with others you could also set up as a partnership or limited liability partnership.
If you source work or projects with the help of a recruitment firm you can also operate directly through the Agency on their payroll under what is known as Agency PAYE or as the employee of an Umbrella Company.
All options come with their own advantages and considerations, so it’s important you understand the different options before deciding on your preferred way of operating.
A good accountant will explain all the options and help you consider your personal and business circumstances by taking into account some of the following factors:
- Contract rate
- Contract length
- Career intentions
- Employment status
- Supervision, Direction and Control (SDC) test
- Attitude towards risks and responsibilities
- Financial discipline
- Administration skills
Although the various options have different tax implications, which affect your take home pay, it is important that this is not be the only factor when deciding on the best option for your business!
A specialist accountant, like First Freelance, will provide you with a personalised report and a financial illustration showing the financial implications of each model to help you make an informed choice.
How does VAT work?
Value Added Tax (VAT) is a tax charged on goods and services. Currently the standard VAT rate is 20% (e.g. lithe invoice for your services is £1,000 you would add £200 (£1,000 x 20%), making the total invoice £1,200).
Your company must register for VAT If the annual turnover of the company exceeds £83,000 (2016/17) in any 12 month period. It may, however, be beneficial to register for VAT even if your turnover will not reach this threshold.
One of the advantages of registering for VAT is that you could benefit from joining the Flat Rate Scheme.
Registering for the Flat Rate Scheme will simplify the operation of VAT and can save money for companies with few expenses with VAT.
Flat Rate VAT means you charge 20% VAT on your invoices, but only pay VAT to HMRC at a reduced fiat rate ranging from 4 – 14.5% dependent on your company’s business category.
You cannot claim VAT back on expenses under this scheme (except on certain capital expenditure over £2,000), but any difference between the VAT you collect from your clients and the amount payable to HMRC is treated as income to your company.
You can reduce your flat rate by a further 1 % until the day before the first anniversary of your VAT registration.
To join the scheme, your estimated turnover (excluding VAT) in the next year must be less than £150,000 per annum. Once you join the scheme you can stay in it until your total business income is more than £230,000 (including VAT).
Can you explain their Nl contribution requirements for both limited company set and sole traders?
If you are a limited company contractor operating outside of IR35, you are free to set your salary at any level and pay Nl at the prevailing rates.
If you draw a salary above what is known as the primary NIC threshold, which currently equates to £8,060 per year, you will incur employees Nl at 12% and a further 2% on any portion of salary above £43,000, known as the Upper Earnings Limit.
It is important to remember that your limited company will also pay employers Nl of 13.8% on any salary you draw above the secondary threshold, which currently equates to £8,112 per year.
A common strategy for many limited company contractors operating outside of IR35, is therefore to draw a lower salary at the primary threshold, the level you incur no employees or employers Nl, and take the rest of the profits out as dividends, which are not subject to Nl. This level of salary will still count as a ‘qualifying year’ towards your state pension.
If, however, you are inside of IR35, you need to take all your income as salary and pay PAYE and NIC on the full amount under what is known as a ‘deemed payment calculation’.
Any good accountant will be able to advice you on the best remuneration strategy for your business and personal circumstances.
If you operate as a sole trader, Nl works differently.
If your annual profits are above the Small Profits Threshold (STP), currently £5,965, you make flat-rate Class 2 National Insurance contributions (NICs) of £2.80 per week.
You also make Class 4 Nl contributions of 9% on any portion of your profits between £8,060, known as the Lower Profits Limit and £43,000, the Upper Profits Limit. You pay a further 2% Nl on any portion of profits above £43,000. Class 4 Nl contributions are paid via Self-Assessment.
Unlike with a Limited Company which allows you greater financial planning, with the ability to set your salary level and therefore dictate the level of Nl you pay, you must pay the income tax and Nl on all of the profits you make in the tax year as a sole trader.
What are legitimate expenses?
If you are a limited company contractor and IR35 does not apply to your contract, generally speaking, expenses that are ‘wholly & exclusively’ incurred for business purposes will be allowable.
If any expenses have a ‘dual purpose’ (i.e. both business and non-business or private purpose) then they will generally disallowed. There are, however, examples where the non-business purpose is merely incidental and the expense will still be allowable.
A good accountant will supply you with a detailed expenses guide and audit your expenses and also help ensure you are claiming all the expenses you are entitled to!
How can accountants help?
Modern small business accountants should be doing more than just doing your monthly, quarterly and year end returns and tax compliance. They should be providing a complete overview and service to your small business and to you personally, combining business and personal tax planning.
Income and dividend tax rates change most tax years and your accountant should be monitoring these and actively suggesting ways in which both you and your business can be as tax efficient as possible, whilst still remaining compliant.
A good accountant will always be proactive about saving you money!
In this day and age, with technology as it is, the software that your accountant uses should, as a minimum, provide:
- Live business bank feeds with accounts that always up to date in real-time
- The ability to invoice, submit expenses and upload your receipts in seconds on the go
- A flexible cashflow view to track money coming in and out
- A snapshot view of your Profit & Loss, available dividends, salary & reimbursable expenses
- Tax Timeline of important tax deadlines, plus what to set aside and pay
- All this should be delivered from any device, anytime, anywhere!
Most importantly check they are specialist contractor accountants with an in-depth understanding of how contractors and freelancers operate, along with a specialist in the minefield of legislation governing the sector, including IR35 and the MSC legislation.
Always look out for a Freelancer & Contractor Services Association (FCSA) Accredited Accountant.
The esteemed FCSA Accredited status is the gold-standard accreditation for contractor accountants in the UK. It’s the quality mark every freelancer and contractor should look for when choosing a firm to support them.
FCSA Accredited Accountants undergo a rigorous compliance audit against the FCSA Code of Compliance established following extensive liaison with HMRC. The Code, published on the FCSA website, is the most stringent and comprehensive standard in the industry, covering the firm’s business services, operations, policies and processes.
The audits are conducted on an annual basis by regulated accountants and solicitors, such as Ernst & Young (EY).
First Freelance is an FCSA Accredited firm.
Where can people find out more about First Freelance?
If you would like more information, or to speak to one of our freelancer and small business specialists, you can visit our website: www.firstfreelance.com.
You can also receive regular updates by liking our First Freelance page on Facebook, or following us on Twitter and Linkedin.
For any freelancers or contractors who are London based, you are welcome to visit us in our offices in lovely Sloane Square!