Finance Guide for Contractors
The decisions IT, engineering and interim contractors need to get right: structure, IR35, banking, expenses and tax.
If most of your work will be outside IR35, run a personal service company (PSC) — you keep more of your day rate and gain pension/tax flexibility. If your contracts will mostly be inside IR35, an umbrella company is usually simpler and cheaper than running a PSC that cannot benefit from dividends.
Limited company vs umbrella
The structure decision for contractors is driven by IR35 status, not by personal preference. Outside-IR35 work suits a personal service company (your own limited company) because you can take a small salary plus dividends and pay employer pension contributions. Inside-IR35 work neutralises those benefits — income is taxed at source as employment income — so the simpler route is an FCSA-accredited umbrella that handles payroll, holiday pay and pension auto-enrolment for a weekly fee of £15–£30.
| Factor | Limited company (PSC) | Umbrella |
|---|---|---|
| Best for | Outside-IR35 contracts | Inside-IR35 contracts |
| Setup time | 1–2 days | Same day |
| Admin | Accountant £100–£150/month | Margin £15–£30/week |
| Take-home (rough) | 75–80% of gross outside IR35 | 55–65% of gross inside IR35 |
| Pension | Employer contributions from company | Personal contributions only |
| Liability | Limited | Employed by umbrella |
IR35 status determination
For medium and large clients in the private sector and all public sector engagements, the end client is legally responsible for determining your IR35 status and issuing a Status Determination Statement (SDS). For small private-sector clients (broadly: turnover under £10.2m, balance sheet under £5.1m, fewer than 50 employees), the determination remains with your PSC.
The three pillars HMRC tests are: personal service (can you send a substitute?), mutuality of obligation (must the client offer work and must you accept?) and control (who decides how, when and where the work is done?). Working practices matter as much as the contract — get an independent review for any contract you intend to run outside IR35.
If you operate outside IR35, take out IR35 tax investigation insurance (£100–£300/year). It covers the cost of professional defence in an HMRC enquiry — which alone can run to £5,000+ regardless of outcome.
Banking setup
A PSC needs a business current account and a savings account for the Corporation Tax pot. Many contractors also keep a second savings account for VAT if VAT-registered. A business credit card simplifies travel expense reconciliation and builds a credit footprint for the company.
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Salary, dividends and pension
PSC extraction is usually a mix of salary, dividends and employer pension contributions, but £5,000 is the employer National Insurance Secondary Threshold — not a universal “optimal” director salary. Compare the Secondary Threshold, Lower Earnings Limit and Personal Allowance alongside Employment Allowance eligibility, other PAYE income, National Insurance qualifying years, company profit and pension plans. Inside-IR35 income paid through an umbrella is taxed as employment income, so this company extraction model does not apply to it.
Use the Director Salary & Dividend Calculator to explore illustrative salary-and-dividend profiles, then have an accountant confirm any change to payroll or extraction. The tool does not replace advice on Employment Allowance, IR35, pensions or your wider tax position.
Expenses you can claim
Common contractor expenses
0/7 · 0%The 24-month rule is the big one for contractors: travel and subsistence to a workplace become disallowable once you know (or reasonably expect) you will be there for more than 24 months. Track contract extensions carefully.
Surviving gaps between contracts
Plan for at least one month per year unpaid. Hold three months of personal outgoings in cash, keep a credit facility available, and use quieter periods to top up the pension and tackle training. A PSC with healthy retained profit and an employer pension habit makes contract gaps a planning question rather than a crisis.
Frequently asked questions
Related guides
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Information on this page is general guidance for UK small businesses and is not financial, tax or legal advice. Tax rules, allowances and product terms change. Always check current information with HMRC, Companies House or a qualified professional before making decisions.