If you’re a freelancer or a self-employed contractor, chances are you are always on the lookout for tips to reduce your tax burden. We got the experts from VatGlobal to explain the top ten tips for tax planning.
- Organize as a Ltd Co
While this may seem obvious, many freelancers and contractors don’t take the time to set up their business structure to maximize their tax savings. A Ltd Co. falls under the Companies Act 2006 and is considered a separate trading entity distinct from the individual. Organizing your business as a Ltd Co. may require a bit of additional paperwork, but it can also result in a savings of between 20 and 30p per £. This is in comparison to the tax burden under an umbrella co, PAYE or identifying as self-employed. (Click here to learn more)
- Use The VAT Flat Rate Scheme When Registering Your Ltd Co.
Freelancers and contractors will find it much easier to work with this type of registration and may discover it can help them save money on taxes. You will pay VAT a flat rate depending on your business income, including VAT. Your trade or profession will determine the fixed rate. HRMC determines the fixed rates for different occupations or industries. To be eligible for the fixed rate, your income must be projected to be less than £150,000 annually, excluding VAT. (Click here to learn more.)
- Draw A Director Salary
Pay yourself a minimal salary as a director of your company. For 2015-2016, this was £883.33 per month or £10,600 annually. This is considered the personal allowance for an individual for income tax. The free allowance for an Employee NIC is £8,060. Anything above this up to £42,380 is taxed at 12%. Amounts over this are taxed at an additional 2%. To learn how much you’ll pay in taxes, use this calculator.
- Claim All Eligible Expenses
You may not be aware of all the expenses contractors and freelancers may claim. These can help reduce your tax burden significantly. If you claim expenses through your Ltd Co., they are taxed at the 20% small business rate. There are very strict guidelines and regulations when it comes to business expenses. The tax authorities watch these closely, so be sure all expenses are legitimate. (To learn more, click here.)
- Correctly Time All Extractions
Most contractors and freelancers will draw out income throughout the year. Timing each dividend extraction can help reduce your tax burden. For the year 2015-2016, a freelancer or contractor could extract up to £28,606 annually per shareholder without accruing additional personal taxes. This assumes they are also collecting the full minimum amount due as a director and are not receiving personal income from other sources. Any income above this amount will be taxed at 32.5%. Amounts above £150,000 will be taxed at 42.5%. (To learn more, click here.)
- Don’t Forget The Employers National Insurance Allowance
Freelancers and contractors with a Ltd Co. are considered Class 1 Employers. For any employee or director salary over £8,112 up to £42,385 annually, the employer’s national insurance rate is 13.8%. There is an allowance of £2,000 which means a freelancer or contractor could earn as much as £22,600 before their Ltd Co. would have to pay employers national insurance.
- Maximize Capital Assets Claims
A business owner is continually investing in equipment, furniture and other hardware for their business. These are capital assets and during the first year following the purchase, you may claim a first-year capital allowance. This works like an accelerated depreciation and reduces your tax burden for that year. The first year allowance for 2015-2016 was £500,000. This amount changes annually according to Budget requirements.
- Always Comply With IR35 Rules
Under IR35, contractors and freelancers are taxed based on their working arrangements. If you don’t comply with the requirements of IR35, you may lose all the benefits earned by organizing as a Ltd Co. The assessment under IR35 is completed each individual contract.
- Always Meet Deadlines For Submitting Files and Data
It is very important to always submit all VAT returns and files on time. Clear Brooks accounting software can help ensure your submissions are accurate and timely. Companies House and HMRC will penalize late submissions and you will pay significant fines. It is best to hire an accountant to help with this process, but you must provide your accountant with complete and accurate data. If you do not provide your complete and accurate data on time to your accountant, Companies House or the tax office, you will be penalized. Your accountant can only work with the data provided, so to ensure your tax submissions are accurate and timely, get him or her the right data at the right time.
- Take Advantage Of Entrepreneur’s Relief
If you find you must sell or close your Ltd Co., you may be eligible for Entrepreneur’s Relief. After all other tax-relief strategies have been applied including dividends and director salary, Entrepreneur’s Relief may be used. This can be applied to any remaining company funds. These funds would then be taxed at 10% which could help reduce your overall tax burden. There are many requirements that must be met to be eligible to use Entrepreneur’s Relief. Personal services companies are limited to £25,000.