The biggest change when working as a contractor compared with say working as an employee is that you will become a lot more aware of the taxes you are paying. This because contractors have a lot more control over their finances and taxes with the added responsibility of making sure this is paid correctly and on time.
As an employee, you pay your taxes via Pay-as-You-Earn (PAYE).
Through the system, income tax and Class 1 National Insurance contributions (NICs) are deducted from your salary before you receive it. Your employer will pay Class 1 NICs of 13.8% on salary you earn above the secondary threshold (£8,840 per annum for the 2020/21 tax year).
If you're contracting through an umbrella company, there won't be changes in how you pay your taxes. Just like permanent employees, your taxes are paid through PAYE.
How you pay your taxes changes if you choose to contract through your limited company. Here are the different taxes you need to be aware of:
- Corporation tax: Tax levied on your company’s profits. The corporation tax rate is 19% for the 2021/22 tax year
- Income tax: As a limited company director, you may need to pay taxes on the salary and dividends you draw from your business. We cover dividend taxes in greater detail in our guides on understanding dividend taxes and taxes, rates and allowances you need to know.
- National Insurance contributions: Limited company directors may also be classed as employees. If you’re paid a salary over the lower profits limit, you’ll have to pay Class 1 NICs as an employee. The company will also pay Class 1 employer’s NICs on salaries the directors receive.
- VAT: Depending on your turnover, you may need to register and pay VAT.