Contractors' Questions: How much tax to pay on freelance earnings?

Contractor’s Question: I am a new to working for myself and seek an overview of what to expect from a tax versus money in my pocket perspective.

Having been hired by a company as a freelance contractor, I will cover specific shifts per month. I was asked to give them the invoices of the shifts in the end of the month. If my shift is getting me paid, say, 300 pounds, how much of this will I have to pay when cutting in the taxman, administering an invoice or when taking account of any other costs?

Expert’s Answer: You don’t say what you will be doing for your client but the first thing you need to clarify is the process your client expects you to follow. For starters I would ask them:

- Do I have to fill in a timesheet or do I just invoice for hours worked?

- Who needs to sign off the timesheet/invoice? (Note: some clients have specific processes that, if not followed, can lead to delays in payment)

- How long before I get paid? Is it weekly or monthly?

- Will I have a contract for services? (Note: This will set out each parties roles and responsibilities – you should read them carefully because there may be penalties if your work is not up to scratch)

- Do I need insurance?

In terms of setting yourself up as a freelance contractor you have a number of options. Which one you choose will determine how, when and how much tax you will pay. The most relevant set-up routes for you would be:

  • Your own Limited Company
  • Sole Trader
  • Umbrella Company

The limited company route will deliver the best net pay (75-80%) with the benefit of limited liability. You could employ an accountant to help you with your invoicing, company accounts and tax returns but there will still be some admin for you, such as making tax payments. There are also legislative risks, such as IR35, to consider.

The sole trader route has similar benefits and drawbacks (but you would not have access to agency contracts due to the tax rules governing recruiters).

If you want to keep things simple an umbrella company may be a better option for you since it will invoice your client, collect the money and pay any tax due. You have the benefit of its insurances and are employed. The downside is that your take home pay will be lower (approximately 60-65% depending on your business expenses). But it is a good option for new freelancers who may migrate to a limited company once they have become used to the processes.

Ultimately I recommend that you obtain some tailored advice. Accountancy service providers will run through the options for you, free of charge, enabling you to make an informed decision. Good luck!

The expert was Julian Ball, legal director at PayStream, a leading supplier of accountancy services to freelance and contract workers.

Monday 15th October 2012