macrobug

A lot of people assume that contractors are rich scummy gits.

It’s true to an extent, so long as you have a long-term lucrative contract. Let’s do some sums on a hypothetical contractor. Numbers are based on a few contractors I’ve spoken to - so don’t assume they relate to me, cos they don’t.

Gross salary if they weren’t contracting: say £50,000.
Net salary if they weren’t contracting: That might leave £32,000 net salary after tax and national insurance has been deducted.
Effective net salary: add on 6% pension payments your company makes and a couple of other percent for miscellaneous benefits like life insurance, and you can call your net salary £35,000. All very approximate of course.

Contracting rate per hour: £50
Hours a week: 40
Weeks a year: 44.

Why 44? Because some of that time you’ll be ill, or on holiday, or will be between contracts. None of that you get paid for.

Income per year: £88,000

Gosh, that’s a lot isn’t it? We can deduct a bit for operating expenses of running the company (accountants etc.) and also for hardware and software, which typically a contractor has to provide. So let’s say:

Effective income into company: £80,000

Now what do we do with that? It rather depends on the Inland Revenue. They have a set of regulations called IR35, under which they assess your contract. If you appear to be like a regular employee of the company to whom your company is contracting, they’ll treat you like an employee and tax that £80,000 as a standard gross income. In which case you can expect your net salary to be about £44,000.

However, if your contracts are riskier, shorter-term, and look more like genuine task-based contracts rather than employment, you are “outside” IR35 and there is another option.

That option is to pay yourself a small salary - say, £6,000 - and take the rest of the cash as company dividends. Since you’re the only shareholder and director, you can do that. Income tax is not due on dividends - woohoo. However, dividends come out of company profits. Company profits are taxable (through Corporation Tax) - but that’s only 19%. So your income will effectively be taxed at 19% (plus a titchy amount of income tax on the £6,000). Net income: £66,000.

Seems pretty appealing hey?

But… (didn’t you know there would be a but?)

• You accept the risk that if you fall ill, or get unemployed, that’s it - there’s no safety net.
• You have to actively try to sell your services.
• If you end up with a cushy low-stress contract for a fixed number of hours a week, the Inland Revenue will decide you’re an employee and tax you accordingly, making the whole thing much less attractive. Contractors will therefore only make really big heaps of money if they are accepting a lot of risk.
• No chance of career progression/pay rises. Not as fully integrated into teams. etc. etc.

For me the biggest downer is the extra risk. For example if you get RSI you’re pretty messed up. Most contractors accumulate so much money that the cash heap acts as effective insurance against such problems (or they can use some of the income to get insurance against such illnesses etc.) Obviously, contracting part-time, I am actually earning less than I did with my full-time job, so I have no such cash pile as protection against such problems. Scary! At least I’ve got a talented and beautiful wife who can support me if it all goes tits up. Can’t you, dear?

Even full-time contractors aren’t happy. I don’t know of a single one who wishes they didn’t have an interesting full-time job.

In my case, taking a contract to bring some income into Macrobug seems like it was probably the right thing to do. But spare a thought for the full-time contractors - they’re probably rich but miserable.

(See Contractor Calculator if you want to play with these figures.)

This entry was posted on Monday, December 4th, 2006 at 1:24 pm and is filed under Business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.