So you’re thinking of becoming a contractor? Perhaps you are looking for the flexibility that comes with working in this way, or perhaps you are working in an industry where all the best jobs seem to go to contractors.
Whatever your reasons for choosing this kind of work, starting out as a contractor means that you need reliable information. We have answered some of the most commonly asked questions for you.
How do I become a contractor?
The first – and probably the scariest – step is to give notice at your current job. Then you can begin looking for contract work. It is possible to look for contract work while still in your job, but most agencies and clients want people who are available to actually start work as soon as possible. A minority of contracts are advertised several weeks in advance, but your options are very limited if you are on four weeks’ notice.
Getting your first contract is the next step. You may already have contacts in your industry who can give you leads to follow up, but most contractors use agencies to find work, particularly when they are starting out.
Then you need to decide how you will operate as a contractor. There are three main options, which this guide will discuss more fully later.
- Sole trader
- Umbrella company
- Limited company or partnership
Once you have made your decision, it is time to negotiate and sign your first contract. What you need to do at this point depends on your own circumstances and how you have decided to operate. You may need professional advice.
Contract work as a sole trader
Working as a sole trader is a fairly simple option. You need to register as self-employed with HMRC and keep basic accounts, something that PayStream’s My CIS service can help with if you are working in the construction industry. You will have to pay income tax at the same rate as an employed person, plus Class 2 national insurance contributions and possibly Class 4 contributions too.
You must be genuinely self-employed to work in this way. Changes to the law in April 2014 means that if you are working via an agency and you incorrectly classify yourself as ‘self-employed,’ your agency may be liable for any underpaid tax and national insurance. If you are supervised, directed or controlled in your work, is it unlikely that you will be regarded by HMRC as genuinely self-employed and an umbrella company, such as My Max, may be more appropriate for you.
The main disadvantage of contracting as a sole trader comes when you are looking for work. Most contracting work is arranged through agencies, and most agencies will not deal with sole traders. They usually prefer to deal with umbrella companies or with contractors operating through their own limited companies.
The other big disadvantage of working as a sole trader is the liability issue: you are personally liable for acts or omissions and for any debts you may incur. You need to consider whether you are prepared to take this risk.
Contract work as a limited company
Operating through a limited company will make it easier for you to get work through agencies. The other big advantage is that, as the name suggests, your liability for any debts incurred by your business is limited. As a separate legal entity the limited company will be liable for its own debts, so as long as you, as a director, do not owe the company money and you do not breach your duties as a director you will not be liable personally for any debts.
A downside of having your own limited company can be that it costs time and money to set up and run. Handling the paperwork isn’t easy when you are also trying to get started as a contractor. However, the good news is that there are companies that can help you with this. For example, PayStream offers a service called My PSC for contractors outside IR35. With My PSC, PayStream helps set up the limited company on your behalf and provides bespoke accountancy advice which is specifically tailored to your needs, making the process much simpler and less scary than you may think.
Contract work with an umbrella company
Working through an umbrella company, such as that offered by PayStream, has many advantages if you are a contractor. If you use an umbrella company such as My Max from PayStream, you become an employee of the umbrella company. That means you don’t have to worry about taxes, IR35 compliance or keeping detailed accounts. You will have the benefit of being in continuous employment, which can help with mortgages or loan applications and means your pension will build up in one place. You will also have access to statutory benefits such as Statutory Sick Pay, Statutory Maternity and Paternity pay. Inclusive insurance is another benefit.
A good umbrella company like My Max will invoice clients for you and then handle your PAYE and NI deductions, just like any other employer and this means that the money you receive is yours to keep. As an employee of My Max you will also have access to an online portal making it easy to join, process timesheets and view payslips.
Using an umbrella company will also make it easier to get work through agencies. As we’ve mentioned, agencies prefer to deal with umbrella companies or limited companies rather than with sole traders, which means you will have access to greater work related opportunities.
Will I pay less tax as a contractor?
This depends on how you choose to operate. If you are working through an umbrella company, you will pay the same tax as if you were employed. If you are not subject to supervision, direction or control (SDC) in the manner of how you do your work you may be able to claim tax relief on your home to work travel and subsistence costs. Click, here for guidance on Supervision, Direction or Control.
The situation is different if you are running a limited company. In this situation, you may be able to minimise your tax bill by paying yourself a low salary and taking the rest of your income in the form of dividends. However, this is only possible if you are outside IR35 and there are risks involved with going down this route. See our IR35 Review Service for more information.
If you are running a limited company inside IR35, you can’t take the low salary and dividends route. All your income has to be taken in the form of a salary and taxed as such, although a discount, for the purposes of tax relief, is applied to your income for the associated administration costs of running your own limited company.
What are my obligations as a contractor?
You are obliged to keep to the terms agreed in your contract(s) with your agency and/or client.
Where you have confirmed that you are not subject to, or to the right of SDC of any person in the manner of how you provide your services you are obliged to keep the umbrella company updated on your SDC status and inform them if there is any change to it.
If you are running your own limited company, you will be the director of the company and there are legal obligations connected with this. For example, you must file accurate and timely company accounts. However, not all these duties have to be carried out by you personally. It is possible to use a service such as My PSC to help with your accounting and paperwork obligations.
If you are contracting in the construction industry, you may have obligations under CIS, (the government’s Construction Industry Scheme). These obligations involve time-consuming paperwork. However, a CIS service like My CIS can handle these obligations for you.
However you choose to go about contracting, you are obliged to pay any tax due. This usually means completing a tax return, which can take up a lot of your time. However, if you use an umbrella company such as My Max from PayStream, you can avoid unnecessary paperwork because the umbrella company is your employer and pays tax on your behalf.
What are the risks?
Every kind of work carries some kind of risk. When your current contract ends, there is no guarantee that there will be more work for you in your industry and your contract can be terminated at short notice. That is a risk you take as a contractor.
However, that does not mean that contracting is always the riskier option. Remember that you are not dependent on a single company to earn a living. You could argue that that puts you in a safer position than an employee, who could be dismissed or made redundant by their employer. You are free to choose where you work, who for and for how much, giving you a flexibility and freedom not enjoyed by other workers.
Although there is always a risk that you will fail to keep up with your paperwork and end up being fined for failing to do something important, like a tax return or even company accounts, you can reduce the risk of this happening by using an umbrella company like PayStream’s My Max or using a limited company service like PayStream’s My PSC service to help with the paperwork and guide you through the process.