Let’s talk about tax baby!

Ok, even inserting tax into a popular Salt-N-Peppa song still won’t make taxes sexy, but its worth a try! In my new article (this one) I will explain the differences between the taxation of PAYE and a contractor working via their own personal service company (PSC).

Personal Service Company (PSC)

I will start with the more complicated structure the PSC, as this is a business in the legal sense, it’s taxed as a business regardless of the number of directors or employees. Business taxes are broken down in the three sections.

First is the Income-tax. As director or employee of the business, you will be paid a salary via the standard PAYE system. This is income and is taxed in the same way as PAYE, your personal allowance will be taken into account and over, and above this, you will be subject to the standard scaled tax system of:

  • Basic Rate – 20% £12,500 to £37,500
  • Higher Rate – 40% £30,931 to £150,000
  • Additional Rate – 45% Over £150,000

National insurance contributions will also be deducted at:

  • 0% up to £183 per week
  • 12% £183 to £962 per week
  • 2% on income above £962 per week
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Next up is Corporation Tax, this is a tax on company profits. Currently, it’s set at 17%, and company profits consist of the money left over after payroll/salaries are paid, and all company bills are paid. Once we have this amount, 17% is allocated to Corporation tax and the remainder is available to be taken as a dividend.

Example breakdown:
Total company income£100,000
Salary (subject to income tax)£40,000
Company Bills£10,000
Sub Total£50,000
Corporation Tax (17%)£8,500
Amount for Dividends£41,500

So with Payroll and Corp Tax completed, we move on to Dividends! Now, this is the profit of the business! And as the director or shareholder, you want your cut of the profits. But you cannot just withdraw this money and start spending. HMRC want their cut of this too.

This is called the Dividend Tax and is a scaled amount paid based on the total figure withdrawn. Luckily you do get a £2,000 tax-free threshold meaning our above example you would only be due to Dividend tax on £39,500. The tax scale is based on the Payroll Income Tax band, which applies to you.

  • Basic Rate – 7.5%
  • Higher Rate – 32.5%
  • Additional Rate – 38.1%

To better explain based on our above example, we would pay higher rate tax on our Payroll Tax income and therefore fall into the 32.5% bracket for dividend taxes. Meaning the Dividend tax is  £12.837 on £39,500 dividend. Our net income would be £26,662.

Wow, that’s a lot of numbers, and that is one of the challenges with running your own limited company. It can be challenging to keep track of your income and now spend the money HMRC will be expecting at the end of the tax year.


PAYE

Now PSC working is just one of the current models in the UK, the other is PAYE either directly with a business or via an umbrella company. In short, taxes via this model are much simpler than a limited company. Let me break it down for you.

Your income through a PAYE model is subject to Income Tax, National Insurance Contributions, and if you opt-in Pension Contributions. These deductions are applied to all of the income, and it only on varies based on the tax code you are allocated by HMRC. The standard rates for as below:

Income Tax –                                                                   

  • Basic Rate – 20% £12,500 to £37,500
  • Higher Rate – 40% £30,931 to £150,000
  • Additional Rate – 45% Over £150,000

Employees National Insurance –                 

  • 0% up to £183 per week
  • 12% £183 to £962 per week
  • 2% on income above £962

Pension –                                                                        

  • 3% of total income

 


Some people may receive a tax code which gives them more personal allowance (tax-free threshold) or less personal allowance. These will be taken into account when the payroll is processed and only affects when the basic rate tax is applied.

On average, a UK taxpayer through the PAYE scheme will pay between 32-40% tax on the total income. With little to no administration requirements compared to the PSC model.

Even More information!

Additional note from me, if you have read any of my other articles, you will be aware of the ever-changing landscape in the UK for contractors who work via their own PSC. With all of these changes, umbrella payroll could be the safest, easiest and most compliant way for you to work as a contractor.

Well I tried to make taxes sexy, and I’m not sure it’s possible, but at least now you understand the differences between PAYE and PSC.