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When factoring in whether you should start a Limited Company or start contracting, it's useful to understand how your pay works and the assumptions behind them.

Here's a few factors you need to know:

1. Limited Company Director Salary

As a contractor or the sole director of a limited company, you'll have to factor in Corporation Tax, VAT and expenses.

Typically, limited company directors will pay themselves a salary of up to the secondary threshold (£8,840 per year for 2021/22).

This is tax-efficient, as it is the maximum salary you can take before you start paying National Insurance and taxes. At the same time, you're still able to qualify for state pension.

2. Director Dividends

Given that you're drawing a minimal salary, most of your income will be drawn in the form of dividends.

Do note that dividends can only be paid out from distributable profits, and your tax rate will change as you draw a higher amount. You can read up all about dividend thresholds here.

3. Corporation Tax

Corporation Tax is currently set at 19% for UK companies (2021/22).

This is calculated based using the formula: Total Revenue - Total Expenses.

4. Expenses

You'll have a range of different expenses you can claim as a limited company like a work laptop, business travel, insurance and accounting.

If you have expenses incurred as a result of running your business, then should absolutely claim for these.

If you don't, you'll wind up paying a higher Corporation Tax:

- £40,000 profit * 19% = £7,600 in corporation tax

- £35,000 profit * 19% = £6,650 in corporation tax

Further information on allowable expenses can be found in our limited company expenses guide.