Do Contractors Earn More Than Permanent Employees?

How much does a contractor earn?

Over the last two decades, the number of people migrating away from full-time employment to the freedom and flexibility of self-employed contracting has skyrocketed. From just 3.3 million people in 2001, there are now almost 5 million contractors working in the UK today, comprising over 15% of the British workforce.

The benefits of such a switch are self-evident. Not only can contractors dispense with their responsibilities to a boss and seek out only clients whom they wish to work with, the potential for independent organisation of their work-life equilibrium is unparalleled. But are there financial benefits to transitioning to self-employment as well? Although complicated and dependent upon a large number of variables, the answer in most cases is a resounding yes.

How much does a contractor earn?

There are three principal ways in which contractor earnings differ from that of an employee and which make the former a more attractive role than the latter from a financial perspective. Let’s take a look at those three factors in isolation:

  • Wage

For starters, contractors generally earn a higher wage per day than their employed counterparts, since companies will often pay an inflated fee to gain sporadic access to specialised skills.

At the same time, contractor earnings are not supplemented by additional statutory rights such as holiday allowance, sick pay and maternity or paternity leave as an employee’s wages are, along with a whole shedload of other perks and benefits depending upon the job in question. Therefore, it makes perfect sense that a contractor would charge more for their time, since they must cover the risks that self-employment brings.

  • Tax efficiency

Secondly, if managed correctly, contractors can manipulate their tax arrangements to pay less to HMRC than an employed individual. Traditionally, this would involve setting up a limited company and paying yourself a modest wage up to the personal allowance (£12,500 for the tax year 2019/20), thus incurring no income tax whatsoever on those earnings. The remaining profits of the company would then be subject to the corporation tax rate of 19% and could either be taken as dividends (typically taxed at 7.5%) or invested back into the company.

There’s even the option to defer those profits until a later tax year to avoid paying the full amount of taxable contributions this time around. Having said all that, the introduction of IR35 legislation has made tax efficiency a more complicated matter for self-employed people – more on that later.

  • Expenses

Thirdly, contractors are also capable of claiming expenses on their daily outgoings, whereas employed people are generally not able to do so. This particularly aspect of self-employment must be managed carefully, since HMRC are both vague and strict about what they deem as claimable expenses.

Food, for example, can be claimed – but only if it is eaten on a day which falls outside of the normal working routine of the individual (daily lunches are unlikely to be allowed). Nevertheless, claiming all overheads (such as office space, insurance and equipment) can save significant sums, making contracting even more attractive from a fiscal perspective.

The IR35 question

The tax benefits mentioned above had previously made setting up a limited company so beneficial to self-employed people that HMRC began to suspect many workers who were employed in all but name were abusing the system to pay a lower rate of tax, while the companies who contracted them also avoided paying employer’s national insurance contributions (NICs). As a result, IR35 was introduced in 1997 to clamp down on this kind of chicanery.

However, the legislation was amended in 2017 to stipulate that all public sector end clients would now be responsible for determining whether the contractors with whom they worked fell “within” IR35. Fearful of falling afoul of the rules and incurring hefty fines, many clients simply swept all of the contractors they worked with into the IR35 dragnet in a better-safe-than-sorry policy – but this meant that both parties were now forced to pay significantly higher rates of income tax and NICs. Contractor earnings were unsurprisingly hampered as a result.

From April 2020, that legislation is set to be expanded even further to include all private sector contracts, as well. This means that end clients (and by extension, contractors too) will have to go to great lengths to demonstrate to HMRC that IR35 is not applicable to their contracts. Even after investing all of that time and effort, there’s no guarantee that the tax office will view the situation in the same way, meaning 170,000 self-employed contractors could be liable to pay thousands of pounds more in tax and NICs from next year onwards.

Having your cake and eating it

Fortunately, there is a way to enjoy the financial advantages of a higher wage and claimable expenses that contracting brings, without any of the tax problems that IR35 can create. By entering into the payroll of an umbrella company, contractors are able to still organise their own working schedules and command higher daily fees than full-time employees, as well as claiming expenses on their overheads. However, since they will become employees in the eyes of HMRC, the need to comply with IR35 will become irrelevant.

Of course, this means that the tax efficiencies mentioned above will disappear, since they’ll be paid according to PAYE rules in the same way that any other employee is – but those benefits are already being significantly diminished by IR35 anyway. What’s more, the umbrella company will also provide all of the supplemental statutory rights that any other employer does.

When the value of those benefits is taken into account, alongside the higher daily rate that contractors can command, it becomes clear that working as a contractor – via an umbrella company – allows Britain’s self-employed community to have their cake and eat it.

Find an umbrella company

If you’re considering taking the plunge and switching to self-employment, it could be a good idea to take shelter from IR35 under an umbrella company. However, it should be remembered that not all firms offer the same services and advantages as each other, which is why doing your due diligence and vetting several options prior to signing on the dotted line is a prudent approach.

Our online comparison tool is the best way to view at a glance which services are offered by which companies and determine who is likely to be the best fit for your unique circumstances. Begin your journey to self-employed satisfaction today!

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