Common money mistakes for contractors

Most people embark upon their journey as a contractor after spending the initial part of their career as an employee, renumerated through a salary from their employer. Making the leap to working for yourself as a contractor, where payment and money matters are largely in your hands, can therefore be exciting but also daunting.

Common money mistakes for contractors

Looking at the most common money mistakes we see made by contractors is a great place to start, partly as what first-timers might get wrong is often not always a breeze for veterans either, writes Christian Hickmott, managing director of Integro Accounting.

Here, exclusively for ContractorUK, I want to share these common money mistakes for contractors – what they are and how you can avoid making them yourself – when working through limited company.

Failing to grasp you and your limited company are two separate legal entities

One of the most common money mistakes for contractors we see that is committed mainly by newcomers is that they don’t grasp at the start that the limited company is an entirely separate legal entity to themselves personally.

It is very important to get this distinction really clear in your head right from day one registering with Companies House, as it has far-reaching implications for the flow of money. Both to the tax authorities and to your own company bank account!

The limited company pays corporation tax on all the profit that it makes in the year. To put that simply, the profit is the amount left over after you have taken your company expenses away from your invoiced amounts. Once that corporation tax has been calculated then the amount left after that is the amount that you can issue to yourself, personally, as a dividend.

Once that dividend is issued then you need to start thinking of yourself personally and instead of profits and corporation tax, you’ll now need to think about your personal income and income tax. Talk it over with an accountant if you fear you’ll make a mistake!

Not respecting cashflow and the timing of tax payments

Quite understandably, it is very common for someone starting off as a contractor to have always had their taxes deducted at source through their employer’s PAYE scheme. So another  common money mistake contractors make is not taking the timescales for payment into account. But even ‘old hands’ can occasionally overlook timescales too, so it’s not just a beginner’s error!

If you are fresh into contracting, remember that your first corporation tax payment is due 21 months from when you start to trade. If you have not thought to save up and account for the tax to HMRC properly, then that is going to be a big cashflow problem down the line. 

The same scenario can unfold with income tax. Instead of having your tax deducted from your salary monthly you need to save up to be able to meet your self-assessment bill, which can be due as much as 22 months after the start of trade.

In addition, a high balance to pay on your first self-assessment will lead to HMRC collecting the following year’s tax through “payments of account”, which gives rise to a ‘double payment whammy’ in one year.

You can see from the above how quickly the tax payments for both you and the company can spiral out of control -- without careful planning.

Forgetting to provide for a rainy day

Day rates for contractors are often excellent compared to salaried roles of the same grade and there are several reasons for that, which is a topic for another day.

However, another of those common money mistakes for contractors that we see is not preparing sufficiently for a rainy day.

It is always a good idea, especially when working as a freelance contractor, to leave sufficient funds in the company to enable you to continue paying yourself should you find yourself between contracts for a couple of months.

Not keeping records to claim expenses

There are several tax-deductible company expenses that are perfectly legitimate business expenses for a contractor to include in their accounts.

To be able to claim business expenses in your company accounts you do need to have kept the correct records, however.

All too often we see contractors (at all stages of their careers) who were just too busy to do some proper record-keeping, and then they lose out on these tax-deductible expenses. Over the year they do add up, so don’t be sloppy with records, receipts or filing. And remember, you pay corporation tax on the company profit, so every legitimate expense reduces profit and therefore corporation tax too, leaving more profit for you, the business owner!

Final thought

Working through a limited company is often an excellent and rewarding choice for a contractor. But a little research and preparation at the start of your contractor journey – and even a refresher if you’ve been freelancing a while – can work wonders to avoid common money mistakes. Whichever contractor-type you identify with more, an accountant can help and ensure you get the most out of this unique way of working.