Tax planning for contractors

by | Apr 13, 2018

No one likes to pay more tax than they have to. Contractors who work through a limited company and are outside the scope of IR35 have 3 main ways to take money from their business:

  • salary
  • dividends 
  • pension contributions.

For most people, using a combination of the 3 is the most tax efficient. 

Salaries for contractors

Company directors are exempt from paying the national minimum or living wage so you can set your salary at whatever level you like.

Many contractors plan on taking a salary of £8,424 in 2018/19. This amount is free from income tax and national insurance contributions (NICs) but is enough to build entitlement to the state pension. 

On top of the personal tax savings, salaries are a deductible expense so you’ll also lower your corporation tax liability. 

It’s possible to pay salaries to other people, such as relatives. 

However, HMRC frowns on people who make high payments to relatives in return for very little work so this tactic needs to be treated with caution.


You can top-up your salary with dividends from your company profits. 

The first £2,000 of dividends above the personal allowance of £11,850 is tax-free for 2018/19. After that, they are taxed at the following rates according to your income tax band. 

These rates take into account other taxable income (such as salary) and you may pay tax at more than one rate. 

Tax band Tax rate
Basic 7.5%
Higher 32.5%
Additional 38.5%

 Any dividends that fall within any unused personal allowance are also tax free. For example, Alexandra pays herself a salary of £8,424, so £3,426 of her personal allowance is unused. When combined with the £2,000 dividend allowance, Alexandra’s first £5,426 of dividends is tax-free.

Your spouse, depending on her/his other overall income, can sometimes be added as a shareholder so they take dividends, including the £2,000 tax-free dividend. 

At first glance, dividends look much more tax efficient compared to taking the same amount as a salary. 

However, dividends are paid out of profits after corporation tax has been deducted so you’ll also need to factor this in when working out your total tax liability. 

Read more about choosing between a salary and dividend

Pension contributions for contractors

Contributing to a pension can help you save for retirement and reduce your corporation tax liability. 

You can squirrel away up to £40,000 a year into a pension without paying tax. 

Contributions made by the company can be deducted from profits before corporation tax. 

Working out whether it’s more tax-efficient to contribute into a pension as a company or as individual involves some serious number crunching. 

We’re on hand to help you run through the numbers, but pension planning is not just about saving tax. 

Your pension savings can make or break your retirement so it’s important to get specialist advice before making a decision.

Talk to us

Everyone’s circumstances are different. Get in touch to discuss tax planning and your business.

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