You as the contractor are becoming an employee of the umbrella company. You submit your timesheets to the umbrella who will in turn, invoice the client (or agency working under) for the work done by you. You will then be paid as a PAYE employee - umbrella fees.
You're usually allowed to claim some basic expenses, however be cautious of umbrella companies that offer special expense policies as they may be encouraging tax avoidance through fraudulent expense claims. This will come back to you if you are not careful!
You typically take home around 60-65% of your contract wage by using a PAYE umbrella company.
Limited Company
You will need to form a limited company and open a business bank account. If you get an accountant they should be able to help get things running. You will then become the director of the company controlling invoicing, company bank account and decides how much to pay yourself (through salary and dividends).
The Limited company contract can either by directly with the client or the agency.
The company can claim tax free expenses for things like travel, subsistence, hardware, software, training, stationary, professional subscriptions, business telephone, accountancy fee and some other expenses relating to the business.
You typically take home about 75-80% of your contract wage through your limited company.
Here is the basic pros and cons to both:
Limited Company Pros
- Very tax efficient
- Claim more expenses
- Flat VAT rate
- More paperwork involved
- Not good for contracts earning < £25K a year
PAYE Umbrella Company Pros
- Easy to use, just need to enter timesheets and expenses (usually through website).
- Everything is deducted for you (NI, TAX, etc.) so you receive the final payment.
- Good for short term contracts.
- Good for contracts < £25K per year.
- Good if you are unsure if contracting is for you so you can test the market.
- More expensive than Limited.
- Reliant on third party umbrella company to get money, deduct fees and expenses and then pay you.
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