Becoming a self-employed contractor is a huge step in your career, especially if you’re moving away from the relative comfort of employment. You might feel a bit nervous, but this is such an exciting time with the freedom to set your own hours, focus on projects you feel passionate about, or even decline work. And the best thing is, you don’t need to give a reason why. The choice is yours!
But what’s next once you decide to get started? The first big decision for most contractors on the road to self-employment is deciding what sort of business structure to operate.
The great news is you have options, such as becoming a sole trader or setting up your own limited company. If neither of these appeal to you, you can work with agencies who’ll help you find the right clientele.
Although this may seem a little overwhelming, good bookkeeping has your back! Keeping on top of your data makes it easier to complete your tax returns accurately, track your goals, and record any expenses.
To help you get started we’ll answer some of the most frequently asked bookkeeping questions which new contractors ask, including:
- What is a contractor?
- What are the key differences between a contractor and an employee?
- What is bookkeeping and why is it important for contractors?
- What type of tax returns do contractors need to submit?
- Are there any expenses I can claim as a contractor?
- What are some good bookkeeping habits I should get in to?
What is a contractor?
Before we get into bookkeeping, let’s discuss what a contractor is. In short, a contractor is just that – someone who ‘contracts’. Clients will normally hire you for a specific purpose or project, for a defined length of time.
A typical contractor will deal with clients for both short-term and long-term projects, and you might even find you have regulars who come back whenever the need arises. This, of course, takes time though. So don’t worry about that too much if you’re just starting!
What type of business is best for a contractor?
Choosing the right structure to set up your contracting business is largely down to your personal preferences, and what works best for your needs. So, what are the most common types of business structures?
|What this means:
You are your own boss! This means you’ll be running the show, finding your own clients, and completely managing your taxes. Check out our sole trading and bookkeeping resources for more.
You’ll still be your own boss, but unlike a sole trader, you’re a completely separate entity from your business.
This means you can’t just keep any profits, so you’ll need to decide how to pay yourself. It’s often more tax efficient if you pay yourself a small salary and take the rest through dividends.
An Umbrella company will ‘employ’ and be the intermediary between you and your clients.
You still have the freedom to pick and choose which clients and projects are right for you, but all the administrative duties (including tax) are taken care of.
This is great if you’re just starting out, so you can hit the ground running with clients (without having to deal with quite so much admin).
An agency is similar to an umbrella company in that they’ll match you up with clients. The only difference is you won’t be employed by them (so you’ll still need to manage your own taxes).
Because you work through the agency, you’ll normally invoice them, and they’ll pay you directly before reclaiming the cost from the client. Which is much easier than invoicing different clients at once!
What are the key differences between a contractor and an employee?
There are some key differences between contractors and employees, and it’s good practice to familiarise yourself with these. This is because tax legislation known as IR35 looks at the way contractors carry out their business in order to clamp down on ‘disguised employment’, where someone who would ordinarily be an employee takes advantage of the tax benefits of working through their own limited company instead.
If a contract is found to be ‘inside IR35’, it means the contractor would otherwise be acting as an employee if their company didn’t exist. There are tax implications for this!
|Pick their hours
|Working hours are set by their employer
|Tell clients what their fees are
|Unable to charge set fees (but may be able to negotiate salary)
|Work with multiple clients at once
|Often have non-competition clauses in employment contract so cannot undertake work for similar clients
|Choose who they accept work from, and what projects they’re involved in
|Less autonomy to pick and choose projects
|Clients won’t make National Insurance or pension contributions
|Employers will make National Insurance and pension contributions on their wages
|Are usually responsible for submitting tax returns and paying the right amount of tax
|Are taxed at source by their employer
|No employment protection or redundancy pay
|Statutory right to redundancy pay and protection against unfair dismissal
Bottom line: Employees have more rights while contractors have more freedom to be creative and choose their work.
What is bookkeeping and why is it important for contractors?
Bookkeeping is a bit like having a diary of the finances in your business. You’ll capture and record every transaction which comes in and goes out. Good bookkeeping is at the heart of every successful business, and it’s especially useful for contractors when you have a variety of different clients, with payments and invoices flying about all over the place.
Using a robust system to record all your financial data in one place makes it much easier to keep track of everything. For instance, you’ll know which customer invoices haven’t been paid yet, or which suppliers you still need to send a payment to. That way you’re less likely to miss a payment and risk tarnishing the relationships you build with your clients.
Can I use my bookkeeping records for my tax return?
You absolutely should! Tax is a major feature of being a self-employed contractor. Recording everything properly in your bookkeeping helps you minimise the risk of penalties for inaccurate or late tax submissions.
Having HMRC breathing down your neck can feel overwhelming, but keeping your accounts up-to-date as you go makes life, and tax, a whole lot easier.
What type of tax return do contractors need to submit?
This depends on what type of contractor you are.
- If you’re a sole trader, you’ll normally need to submit a Self Assessment tax return and pay income tax based on your profits, and make National Insurance contributions.
- A limited company pays Corporation Tax on the profits that it makes, and then you’ll pay income tax on anything you pay yourself out of the business.
Operating as a limited company can be more tax-efficient, which is why it’s crucial to be aware of the IR35 rules we mentioned earlier.
Do you have subcontractors?
If you’re a contractor working in the construction industry and you use subcontractors, you’ll also need to register for the Construction Industry Scheme (CIS) and submit CIS Returns.
You’ll only need to submit a CIS return for the months you use a subcontractor but will still need to let HMRC know why you’re not sending a return the rest of the time. There are lots of resources and guides on this, so don’t worry too much!
Are there any expenses I can claim as a contractor?
Yes… and that’s why bookkeeping is so important! As a contractor, you’re likely to incur business expenses in order to run successfully. Keeping track of all these will help you claim tax relief on everything, so you don’t end up paying more tax than you need to!
This includes but is not limited to:
- Travel costs
- Use of home office
- Client or staff entertainment
- Accounting costs
- Bank charges & interest
- Phone costs
Good bookkeeping practices
Great bookkeeping equals a happy contractor! Here are some tips to get you started.
Automate as much as possible
Automating your bookkeeping minimises the risk of errors and helps save heaps of time so you can crack on with your business.
For instance, setting up Bank Feeds means you can automatically enter banking transactions into your bookkeeping, without needing to spend ages typing everything out. You can even create Bank Rules to automate the checking process, or use automated payment reminders to nudge clients to pay on time and avoid disrupting your cashflow.
Use cloud-based software
When running a busy business, you don’t need a to-do list of all the receipts you need to store and invoices to send out looming at the back of your mind until you get back to your desk.
Cloud-based software means you can update your bookkeeping wherever you need to. This ensures accurate, up-to-date records, and no second-guessing when it comes to submitting those tax returns!
Keep your business and personal finances separate
This is a requirement for limited companies, but even if you’re a sole trader this is great practice. It makes life so much easier, so you know exactly what’s what, and you’re never confused about a specific expense or invoice.
For more tips, check out our handy Pandle Guide!