Like a lot of people in the UK, I suspect, I’ve been a PAYE employee for the majority of my working life. In fact, technically, until very recently, all of my working life. This tends to result in two truths: your tax is taken at source and you receive the NET amount in your pay and I’ve never filled in a tax return. With respect to the tax return I’ve always worked on the principle and advice that if you’re not sent one, then don’t fill one in? To be fair, my tax affairs have been covered by PAYE so I was right never to push for one.
I used to run my consultancy work through an Umbrella Company, which effectively makes you a PAYE employee, but now I’m running my own limited company. I feel this is commensurate with the less stable and less benefit-focused model of my project-based, defined ending services my company is delivering, and it also means I no longer appear like a PAYE employee and have to become half an accountant.
This means I’ve broken out of PAYE completely (well, not completely, but almost as complete as it gets).
So, basically I’ve got myself an accountant (Stuart Hall at www.stuarthall.net, who is worth checking out, great guy and very cost effective) and I’ve invested in FreeAgent (www.freeagent.com, also worth checking out but get my referral code) a SaaS accountancy solution perfectly suited for small businesses, consultants and contractors.
I could have mangled something together with Excel but I have a strategy with FreeAgent. In the first instance it makes things easy to keep track of (balances, expenses, project profit, outstanding invoices, pay, dividends, tax and when they’re due, etc) and it combines this with an educational element as it instils good practice on how to manage things. This educational element is a big thing for me. It’s slight overkill for what I’m doing currently but I’m happy with it.
At the moment, I’m getting an odd pleasure from tracking expenses quickly and easily and, more importantly, raising invoices which is only matched by seeing the money hit the bank account. It just feels better working things through a company account. I’m sure this will get boring at some point but it has a certain thrill over a traditional pay check at the moment.
As is usual with this blog it tends to focus on what I’m finding interesting and thinking about, so I apologise to anyone who finds this common knowledge, but the transition for me has been interesting and informative. What follows is some observations around the differences incurred when you break out of PAYE.
Observation one: You pay less tax. This mounts up significantly. You pay 20% tax on your company profit and as long as you don’t take your money out too fast that is all you pay. 20% Period. PAYE gives you very little options other than to suck up ever increasing taxes at ever lower brackets. Obviously, this does mean your income for the year has to be less than the 40% PAYE tax bracket otherwise you are hit for tax on your dividends. The hit is not so much in tax but the speed at which you can pay yourself over time, but that brings me to my next point.
Observation two: You have untaxed income to work with. You have to pay corporation tax on profits but that doesn’t have to be declared until the end of the financial year and then not paid until circa 9 months after that period. So you have the money for your tax bill in your account in your control for a whole 9 months before it’s paid (or more as it’s been accruing all year). Look back at the Director’s Loan and put it somewhere else that’s useful – again as long as you’re not seeking to spend it. Depending on what financial set-ups you have on your personal finances this opens up 100% of your earnings for an extensive period to work for you in some way before the tax man grabs his chunk.
Observation three: VAT gives you money. Amazingly, you make a profit on VAT as long as you’re not spending a lot of money on items with large amounts VAT (and even then you can claim that back if they are large rather than the death of a thousand not large enough cuts). This is due to the fixed rate VAT scheme. You charge VAT on you invoices at 20% and pay it out to the government at a lower rate. In short, you make a profit on VAT. That can amount to an extra £300 a month and the money you do owe doesn’t have to be paid immediately.
Basically, without doing anything illegal or even stretching any of the rules in any shape or form, or moving into an area that could be considered tax avoidance, options become available to use your financial assets more effectively. You have options. While under the PAYE regime you have no options other than to pay your tax out immediately as it’s taken away at source. You never have it in your hands to do anything. PAYE is supposed to be convenient, but it hasn’t even been that recently as my tax code has bounded around ridiculously despite being the most basic of PAYE employees.
What would the country be like if everyone had all their earnings, could see it in their bank for a period of time, only to have to pay it to the tax man sometime later? Very different I suspect, as not ever seeing it and just working out your take home pay is a quite different prospect to having money, however fleetingly, and having to work out how much you have to hand over.
The one problem all this does create is there is some advantages in having a permanent position. You’re not having to hustle for the next client manage to deliver your company’s services to or manage gaps in your earnings, though that can be by choice (like the two months I spent at the end of 2012), etc. In truth, permanent roles aren’t as permanent as they used to be so unless your sitting in the same company for 5+ years it’s about the benefits (pension, sick pay, holidays, etc).
It makes you very selective about the permanent jobs you’ll consider. This is good for yourself and also makes you a good candidate. It puts limits on you though as you carefully consider the nature of the job and whether it is something you really want to do compared to the freedom you currently have (balanced against the risks). The financial angle is always difficult as your take home pay is high, even at modest consultancy rates (and ignoring all the flexibilities outlined which add up), resulting in jobs that pay even remotely equivalent being in very short supply in the North East.