As a contractor, what is a reasonable mix of salary, expenses and dividends?

As a contractor, what is a reasonable mix of salary, expenses and dividends?
Choose a Name: The name has to be unique, obviously, and not likely to be confused for someone else’s existing name. The best reference point is the Companies House website – www.companieshouse.gov.uk – which has a simple search facility so you can check your chosen version. Also, try to avoid names that are specifically related to your line of work, just in case you want to change careers later: imagine selling cars though a company called Al’s Bakery.
Decide on Share Ownership: Is this just you, or you and your spouse, or you and two or three other people? This is important, because it defines how to allocate the Ordinary Shares In the company. Dividends are paid in direct proportion to numbers of shares held. A husband and wife typically have 50% each, for example, but if one is already earning money, be aware of the impact of the share income on their tax position. Share allocation can be changed after the event. There are several variations on share management; but for anything other than a simple allocation of ordinary shares, get expert advice.
Register at Companies House: There is an online system you use to set up your company and pay the registration fee. It is fairly simple to use. One question it will ask is who the directors are. For a typical small contractor company you only need one but there’s no reason not to have more. Although not strictly necessary any more, it also helps to nominate a Company Secretary: this could be the same person, but it’s more sensible to have someone else, a partner or relative for example.
Register a Memorandum of Association: Something else to do while you are at Companies House. At its simplest this is a document describing what your company is for and how you wish to run it. You can do it yourself, but the document can have legal implications in a tax investigation so do some online research for a suitable template from sites such as www.simply-docs.co.uk or www.clickdocs.co.uk.
Set up a Bank Account: This has to be a business bank account. Banks are increasingly wary of new business accounts, so you will have to answer some detailed questions and it will help if you have some professional references and a signed contact to demonstrate you actually will have an income.
Register for VAT: You have to do this if your annual income is in excess of a set amount (currently £67,000 pa) but it Is advantageous to register anyway. VAT and the Flat Rate Scheme are discussed in more detail elsewhere.
And that’s it. It sounds complicated but is in fact quite straightforward. You can also take the easy way out; either use a company formation agent, or there are several accountants who specialise in contractors who will set up all if the above for you for a small fee, or even for free, as well as providing expert support. Finally keep track of all your various expenses setting the company up, since you can reclaim these once you start trading.

If you are in business on your own account and working through a limited company, how you take money from the company to pay your bills is entirely up to you. There are no set rules you need to adhere to about how you do it.

However, how much tax you pay will depend very much on how you structure the payments from your company to you. This can get complicated, especially if there is more than one shareholder to consider, so it is best to get professional advice at first and to review that advice as the taxation landscape changes. However, there are some broad guidelines.

You can take any salary you like or none at all. You need to think about your personal tax-free allowance though; this is the amount you are allowed to earn before tax becomes due and is set by your Tax Code.  Therefore you can take that amount of money as salary and not pay any income tax on it. You should also remember that a range of state benefits depend on you paying National Insurance contributions. These are due once you exceed the earnings threshold (currently £110 a week). So the absolute minimum to pay yourself is £5720 a year, or your personal tax-free allowance, which ever is the higher.

Dividends are payable from net profits after Corporation Tax. You can take them at any time, and as often as you need to, provided the financial status of the company is such that it can afford to pay them. Because dividend payments attract a tax credit – to offset the Corporation Tax already paid by the company – dividends up to the upper-earnings limit – the point when the higher rate of income tax kicks in – will not be liable to further income tax. Once you go over that limit, tax is due at the higher rate less the tax credit; at the time of writing this means an effective tax rate of 22.5% (this is because the tax rates for dividends are 10% and 32.5%, both reduced by the 10% tax credit; hence zero extra tax at lower rate and 22.5% at the higher). Dividends are not liable to NIC payments.

Despite what some umbrella companies claim, expenses are not income. In fact, if properly calculated they are income neutral. Provided you have actually spent the money and that you spent it wholly and exclusively as a result of your work, you can reclaim it tax free. It is not, however, tax-free income, and if you are making money on expenses you are probably doing something wrong.

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