What are the benefits of effective tax planning as a contractor?

With the 2024/25 tax year almost upon us, there’s never been a better time to think about tax planning, writes Bright Ideas Accountancy director Michael McCullion. It’s crucial to both minimise how much you’re taxed by HMRC and to maximise your take-home pay.

Before April 6th 2024 arrives, there are a number of things you could do to prepare your finances in a future-focused way. From claiming expenses to succession planning, let’s explore seven top ways to benefit from effective tax planning as a contractor.

1. Business structure

How your business is set up will affect your pay, and therefore how much tax you’ll incur.

A limited company is usually the most tax-efficient model for contracting, especially for outside IR35 engagements. The ways in which a limited company is more tax-efficient include:

• Ability to restrict the pay that is subject to personal income tax
• National Insurance savings

Plus, ‘LTD’ has other advantages for contracting too. The business has separate liability, which isn’t the case when operating as a sole trader, and might be seen as more reputable and trustworthy.

2. Involving a spouse

If you have a spouse, then you can further benefit through your limited company structure. There’s the potential for a spouse to get involved if they’re not utilising their Personal Allowance or basic rate band. If they have a genuine viable role in the company (for example, carrying out administration or accounting tasks), then they warrant a salary and can go on the company payroll.

An alternative to this is to make them a shareholder. Dividends are split between shareholders based on share split percentages. So, if you have a spouse not utilising the full £50,270 for the 2024/25 tax year, you can utilise their tax-free allowance and basic rate tax band.

3. Expenses

As a contractor, you’ll want to claim for any relevant expenses (i.e. those used wholly and exclusively for business purposes), as these can be deducted from your taxable profits.

While directing your own limited company, there are various expenses that may apply to you. Some key examples are:

• Travel – such as mileage, parking, and the cost of public transport
• Staff – like subcontractor costs or salaries (if relevant)
• Finance-related costs – including insurance or bank charges
• Advertising or marketing – such as website fees
• Training courses related to your line of work

4. Compliance with tax laws

The most effective tax planning ensures you’re prepared for any future changes in legislation.

This will reduce the chance of being hit with a penalty, fine, or bill from HMRC which you weren’t expecting.

Various rates and allowances will change every tax year. It’s also good to be aware of the latest in IR35 and your employment status for tax purposes.

The IR35 legislation has undergone significant reforms since April 6th 2017, making it a key consideration for assignments in both the public sector and (since April 6th 2021), the private sector.

For example, if a contract is inside IR35, then this may impact your decision to use your limited company to execute it. You may instead choose to operate via an umbrella company on an assignment caught by IR35 or the Off-Payroll Working (OPW) rules. But using an umbrella in this instance would adversely affect your take-home pay, and your tax planning because you’d have much less control over it.

5. Succession planning

When it comes to closing down your contractor business, retirement or pension planning should be a key consideration – and I’d recommend planning ahead for this stage, even if it’s a long time away.

Rather than taking dividends in the higher rates, you can build up the reserves in the company or put money towards your pension pot – this is much more tax-efficient.

The current pension annual allowance is £60,000. You can gain tax relief on this. It’s a good idea to pay towards a pension as it counts as a deductible expense, meaning you could save up to 26.5% on corporation tax.

6. Retiring in the short term

If you’re retiring in the short-term future, an alternative to the above type of succession planning is the voluntary liquidation route. It provides the option to extract all company assets with Capital Gains Tax (CGT) applied, instead of income tax, which could mean it works out financially-better.

In the event your limited company has been trading for more than two years and you own at least 5% of the shares, then you can take advantage of Business Asset Disposal Relief -- a flat 10% rate on all gains of qualifying assets.

You should note that you can claim up to a total of £1million in Business Asset Disposal Relief over the course of your lifetime.

7. Get the most from effective tax planning -- spelt A-C-C-O-U-N-T-A-N-T

You now know seven top strategies to make the most of your limited company and financial affairs – but there are others. A pro-active and knowledgeable accountant can help ensure you’re fully boosting your tax-efficiency and are compliant with all HMRC requirements, while still optimising your take-home pay. Reach out to us today!