IT Contractor, Private Ltd Company & Tax credit

dark_stranger

I am due to start a new job as a IT contrator, where i will be setting up a private ltd company & paying mself a lower wage as an employee instead of the actual amount my private limited company receives. I would then pay myself dividends, of an amount my accountant see's fit. My question is, i knows that tax credit looks at your salary & therefore as i will only be receiving a lower wage, could i carry on claiming tax credit for my kids?

irs101

No, your tax credit claim will take into account both your wage and dividends. But there are some ways you can save tax and claim more tax credits.

I'm sure your accountant has already told you that the most tax efficient way of remunerating yourself is to pay yourself a wage of £4,895 - equal to the personal allowance. That way you pay no income tax and minimal national insurance - but still preserving your contributions record for benefits purposes. You pay yourself the rest in dividends (although the Chancellor has started to tax them more heavily recently).

With tax credits, the strategy depends on how much you think you might earn. If you expect to make £20-30K (depending on the number of children) or less, the only strategy you can really play is to restrict increases in income to £2,500 (holding any excess within the company) that way you can benefit from the £2,500 disregard every year. Some advantage but relatively small.

If you expect to earn more than this, for example £50K a year, normally you would only get the family element every year (£545). But if you varied your income each year, so in year 1 pay yourself an income of £5,060 (£4,895 wage and £165 dividend) and get maximum tax credits. The next year pay yourself £95K and get no tax credit. And keep repeating. You'll be several thousand pound better off.

Of course it's not without problems. Firstly you need the financial flexibility to be able to cope with having a reduced income every other year. Secondly, dividends are not substitute wages - paying yourself a monthly dividend would be frowned upon by HMRC - most companies pay no more than 2 dividends a year. Thirdly, this kind of tax credit strategy may trigger the HMRC risk rules and they may be interested in investigating why your income fluctuates so much from year to year, so be prepared for some hassle and be meticulous in your record keeping. Fourthly, you need to make sure you are a proper contractor - that it's not disguised employment - otherwise you are under the so-called IR35 rules.

Obviously you should discuss this with your accountant before embarking on such a strategy. But, as I understand it, it's completely legal. However some people round here regard this sort of thing as morally dubious. I'm making no comment on that aspect and am just looking at it from a purely factual perspective (although I'm now going to put on my hard hat and flame-retardant suit )

irs

martinpike

In my view by providing such detailed advice you are endorsing the practice.

Speaking as a higher rate taxpayer, I'm happy to pay my fair share. I feel fortunate to be in that position, and have no desire to abuse it.

rrwfotr

martinpike wrote:

In my view by providing such detailed advice you are endorsing the practice.

Speaking as a higher rate taxpayer, I'm happy to pay my fair share. I feel fortunate to be in that position, and have no desire to abuse it.

Speaking as an person that has done IT contracting in the past, I am fully aware of the situation you are in. As contracts can be quite hard to find you need to find ways of saving money as you may be work for long periods without any income.

martinpike

rrwfotr wrote:

Speaking as an person that has done IT contracting in the past, I am fully aware of the situation you are in. As contracts can be quite hard to find you need to find ways of saving money as you may be work for long periods without any income.

That's not what this post is about. It is clearly about tax avoidance.

And it's not only about avoiding income tax, which is bad enough, it's about claiming benefits too, which is taking the absolute mickey in my opinion.

loobs40

Before you start talking dividends etc have you read up on IR35 and is your accountant fully au fait with the consequences?

loobs40

martinpike wrote:

That's not what this post is about. It is clearly about tax avoidance.

And it's not only about avoiding income tax, which is bad enough, it's about claiming benefits too, which is taking the absolute mickey in my opinion.

And your opinion is quite valid. But taking the moral high ground serves absolutely nothing in this thread. Nothing he /she is suggesting is in any way illegal, so why do you feel the need to wag your finger ?

Pennywise

Yes, by doubling dividends one year and paying none the next, you do get substantial tax credits in the "no dividend" year, but you also lose approx £30k of "basic rate band". More of the dividends are taxed at higher rate in the "high dividend" year. This would roughly amount to £7,500 extra higher rate tax which wouldn't have been paid if the dividends were equal every year. So the increase in tax credit has to be offset against the additional £7,500 of higher rate tax. Swings and roundabouts and not as good as it first sounds!

martinpike

loobs40 wrote:

And your opinion is quite valid. But taking the moral high ground serves absolutely nothing in this thread. Nothing he /she is suggesting is in any way illegal, so why do you feel the need to wag your finger ?

I disagree with you. I believe it does serve a purpose. It encourages debate, which is exactly what it seems to have done. Thanks for that!

mutley74

dont bother setting up your own LTD co. go with a composite company and they will do all the paper work etc for you for a small fee each week.
Try brookson.co.uk one of the biggest companies.

If you do join let me know cause i someone like me recommends you then they get a referral fee but i have a contract with brookson to give m referral fee to charity, which is roughly ~ £80.

irs101

Pennywise wrote:

So the increase in tax credit has to be offset against the additional £7,500 of higher rate tax. Swings and roundabouts and not as good as it first sounds!

That's a good point and I haven't done the sums (not being in this position myself) but perhaps the income was too high in the example I chose - there must be a crossover point where it becomes unfavourable again, although that will vary depending on what tax credits you are eligible for.

Of course you can combine this strategy with making pension contributions in the high dividend year, and of course make all your charitable donations in the high dividend year.

irs