Who pays more tax – contractors or employees?

9 December 2019
By Bryan Smyth

A growing number of people in Ireland are working as a contractor. With the rise of the gig economy, some organisations are making the decision to hire contractors rather than employing full-time staff. Sometimes this decision is driven by the company, sometimes by the individuals themselves as they seek to alter their lifestyle.

But who stands to benefit most from this change in the business landscape – employers or contractors? To find out, this article looks at how becoming self-employed could affect your earnings and the tax you pay, as well as examining some of the pros and cons of becoming an independent contractor.

What is a contractor?

At first glance, it seems like it should be easy to know whether you are an employee or a self-employed contractor, but it can be confusing.

In law, there is a difference between a contract of employment (which applies to a standard employee-employer relationship), and a contract for service (which applies to an independent or self-employed contractor).

Usually, it is clear whether an individual is employed or self-employed, but with more and more companies hiring freelancers, it’s not always obvious which category workers fall into. Especially as some contractors only work for one organisation, just like a regular employee.

To determine whether you should be classed as an employee or contractor, consider whether you have control over what, how, when and where work is carried out, and whether you can sub-contract this work to others.

Will I pay more tax?

Your classification as an employee or contractor will have significant implications for the way you pay tax. And while self-employment might offer more freedom in the hours you work, it will place you outside the Pay As You Earn (PAYE) tax system.

That means the company you are working for is not obliged to contribute Pay Related Social Insurance (PRSI) on your behalf, or to offer you any of the other benefits it would offer to a regular employee. In fact, this may be a strong driver for some employers wanting to make the switch to hiring contractors in order to minimise their employment and tax liability.

In any event, if you are deemed to be operating as an independent contractor, you will need to register with Revenue and file your own tax return under the self-assessment tax system.

What are the cons for contractors?

Job insecurity can be a major factor. To account for this insecurity, along with the lack of holiday or sick pay, you will need to be careful in working out your fees.

Furthermore, with no employer paying your PRSI, you will need to pay class S PRSI at a rate of 4%. And although the class S contribution does add to your state pension, you won’t have any entitlement to benefits such as maternity pay or illness benefits. You may want to consider taking out a sick pay insurance policy, but this will incur a cost.

Finally, there’s the hassle of extra admin. You will need to file your own tax return under the self-assessment system, calculating your own PRSI and Universal Social Charge (USC). Everyone earning over €13,000 gross income is eligible to pay USC, with an extra charge of 3% if your non-PAYE income is over €100,000.

What are the pros for contractors?

The primary advantage is flexibility. You are in control of your own time and workload as a contractor and can take on diverse jobs at multiple companies without negatively impacting your CV.

This is the flipside of that job insecurity mentioned earlier. You’ll need to charge a premium daily rate to cover potential holidays and sickness, as well as any overheads you may incur. This means contractors are often payed more than employees – and with a little bit of planning, you can take home more of this money.

For example, establishing a limited company may give you more freedom over when and how much you pay yourself so you can smooth your tax liability. Set up an executive pension and the company can make employer contributions.

You’ll also be able to offset common contractor expenses against your income including accountancy fees, materials, phone bills and motor expenses. These allowable deductions can help you reduce your tax liability. Lastly, bear in mind all self-employed people can claim Earned Income Tax Credit of €1,350.

Enlisting a tax specialist, such as Tax Return Plus, can help contractors manage these variables. Not only can a tax agent calculate your income tax accurately, they can also file the return on your behalf, eliminating some of the hassle associated with self-assessment tax.

Weighing it up

Whether you’ve taken the initiative to become an independent contractor, or fallen into freelancing by chance, focusing on your tax liability is a vital step towards making self-employment pay.

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