You've landed your first contract, or you're about to. Now you need to actually become a contractor: set the business up properly, make sure you get paid, and stay on the right side of HMRC and Companies House.
That first year is when most of the avoidable mistakes happen. Missed registration deadlines, a muddled bank account, no clue whether a contract sits inside or outside IR35. None of it is hard once you know the order to do things in.
This guide is a practical, first-year checklist for becoming a contractor in the UK. It's written for people going contract for the first time, whether you plan to work as a sole trader or through your own limited company. Figures are for the 2025/26 tax year.
<h2 id="structure">Sole trader or limited company: which should you choose?</h2>
This is the first real decision, and it shapes everything else.
As a sole trader you and the business are the same legal person. Setup is light, admin is lighter, and you report profits through Self Assessment. You're personally liable for business debts.
As a limited company the business is a separate legal entity. You're usually a director and shareholder, you take money out as a mix of salary and dividends, and the company pays Corporation Tax on its profits. There's more admin, but more flexibility and limited liability.
For contractors, three things often push the decision towards a limited company:
- Agency and client requirements. Many agencies and end clients will only engage a limited company, not a sole trader.
- Tax efficiency at higher day rates. A salary-plus-dividends mix can be more efficient than sole trader profits once income rises, though this depends heavily on your IR35 status (more on that below).
- Liability and credibility. A limited company keeps personal and business risk separate and can look more established to clients.
If you're testing the water with one short contract, sole trader can be the sensible start. If contracting is the plan, most professional contractors operate through a limited company. We walk through both routes on our contractors hub, and if you're weighing the structure question seriously, our limited companies guide goes deeper.
A quick comparison:
| Feature | Sole trader | Limited company |
|---|---|---|
| Legal status | You and the business are one | Separate legal entity |
| Liability | Personal, unlimited | Limited to the company |
| Main tax | Income Tax + Class 4 NIC on profits | Corporation Tax on profits; tax on your salary and dividends |
| Registers with | HMRC (Self Assessment) | Companies House and HMRC |
| Admin level | Lower | Higher (accounts, confirmation statement, payroll) |
| Typical fit | Testing the water, lower day rates | Ongoing contracting, agency work, higher rates |
<h2 id="setting-up">How do you set up as a contractor in the UK?</h2>
The setup steps differ by structure, but the principle is the same: register with the right bodies and do it on time.
Setting up as a sole trader
You need to register for Self Assessment with HMRC. The key deadline is that you must tell HMRC you need to file by 5 October following the end of the tax year in which you started trading. Miss it and you risk a penalty.
You only need to register and file once your self-employment income goes over the £1,000 trading threshold for the tax year. Below that, the trading allowance may cover you. Once you register, HMRC issues a Unique Taxpayer Reference (UTR), which you'll use to file.
Setting up a limited company
Forming a company means registering (incorporating) with Companies House. According to gov.uk, you'll need to:
- Check the structure suits you and choose a company name that's available and not infringing a trademark.
- Appoint at least one director (a secretary is optional).
- Identify shareholders and any People with Significant Control (anyone holding more than 25% of shares or voting rights).
- Prepare the memorandum and articles of association.
- Register with Companies House, giving a registered office address and a SIC code for your activity.
- Register the company for Corporation Tax (usually within three months of starting to trade).
You'll also likely need to register the company as an employer for PAYE if you're going to pay yourself a salary. Getting the formation, registers and statutory filings right from day one is exactly what our company secretarial services are built for.
<h2 id="ir35">What is IR35 and why should a new contractor care?</h2>
IR35, also called the off-payroll working rules, is the single most important concept for a limited company contractor to understand. It exists so that someone working like an employee, but through their own company, pays broadly the same Income Tax and National Insurance as an employee would.
The contract is either:
- Outside IR35 - you're genuinely in business on your own account. Normal company tax rules apply, and the salary-plus-dividends approach is available.
- Inside IR35 - the engagement looks like employment. Tax and National Insurance are deducted broadly as if you were employed, which removes most of the tax advantage of the company.
Who decides depends on the client. For public sector bodies and medium or large private companies, the client assesses your status. For small private clients, the responsibility stays with your own company. HMRC's Check Employment Status for Tax (CEST) tool helps you check.
This matters from day one because your IR35 status changes how much you take home and how you should structure your pay. Get a contract review before you assume you're outside. Our IR35 contractors guide explains the status tests and what to look for in a contract.
<h2 id="getting-paid">How do contractors actually get paid?</h2>
Getting paid cleanly is a setup task, not an afterthought.
Open a separate bank account. A limited company must keep its finances separate from yours, so it needs its own business account. A sole trader isn't legally required to have one, but a dedicated account makes bookkeeping far easier and is strongly recommended.
Invoice properly. Each invoice needs your business details, a unique number, the client's details, a clear description, the date, the amount, and payment terms. If you're VAT-registered, the invoice must show your VAT number and the VAT charged.
Know your VAT position. You must register for VAT once your taxable turnover goes over the £90,000 threshold (current, from 1 April 2024). You can register voluntarily below that if it suits you. Many first-year contractors stay below the threshold, but keep an eye on a rolling 12-month total.
Set money aside for tax. This is the habit that saves first-year contractors. Tax isn't deducted at source when you invoice, so a slice of every payment belongs to HMRC, not to you. A separate tax savings pot stops the January bill becoming a shock.
To sanity-check what you'll actually keep at a given day rate, run the numbers through our take-home pay calculator before you commit to a contract.
<h2 id="compliance">What records and taxes do you need to stay on top of?</h2>
Staying compliant is mostly about good records and meeting deadlines.
Records to keep
Keep every invoice you raise, every business expense and receipt, bank statements, and (for a company) mileage and dividend paperwork. Sole traders generally keep records for at least 5 years after the filing deadline; companies keep them for at least 6 years. Good bookkeeping from month one means year-end is calm, not chaotic.
The taxes a contractor meets
| Tax | Who pays it | Notes (2025/26) |
|---|---|---|
| Income Tax | Sole traders, and company directors on salary/dividends | Personal Allowance £12,570; basic rate 20%, higher rate 40% |
| Class 4 NIC | Sole traders | 6% on profits between £12,570 and £50,270, 2% above |
| Corporation Tax | Limited companies | 19% on profits up to £50,000; 25% above £250,000 |
| Dividend tax | Company shareholders | £500 dividend allowance; then 8.75% (basic), 33.75% (higher) |
| VAT | Businesses over the threshold | Register once taxable turnover exceeds £90,000 |
Key deadlines
- Register for Self Assessment: by 5 October following the end of the tax year you started.
- Online tax return and balancing payment: by midnight on 31 January following the tax year.
- Payments on account (if due): 31 January and 31 July.
One more thing on the horizon: Making Tax Digital for Income Tax begins on 6 April 2026 for sole traders and landlords with qualifying income over £50,000 (based on 2024/25). If that's you, you'll need to keep digital records and report quarterly, so it's worth setting up compatible software early.
<h2 id="example">Illustrative example: a first-year limited company contractor</h2>
Illustrative example. Maya leaves employment to contract through her own limited company. Her contract is assessed as outside IR35, and the company invoices £5,000 a month, so roughly £60,000 of fee income across a full year (before any expenses).
Here's the shape of how that money is taxed, using 2025/26 figures:
- Company income. The company receives the fees. Allowable business costs (software, accountancy, equipment) and Maya's salary are deducted before Corporation Tax.
- Salary. Maya takes a modest director's salary. Salary is a company expense, so it reduces the company's taxable profit.
- Corporation Tax. The company pays Corporation Tax on what's left. At this profit level, that's the 19% small profits rate (profits up to £50,000).
- Dividends. Maya draws remaining post-tax profit as dividends. The first £500 of dividends is covered by the dividend allowance; dividends within the basic rate band are taxed at 8.75%.
Two figures to sense-check the dividend side: a higher-rate taxpayer pays 33.75% on dividends in the higher band, and the basic rate band runs to £37,700 of taxable income above the Personal Allowance. The exact split between salary and dividends, and the final take-home, depends on her other income and expenses, so this is the structure rather than a precise quote.
The point isn't the precise pound figure. It's that an outside-IR35 limited company contractor is taxed in layers: Corporation Tax on company profit, then personal tax on how she draws it. For your own numbers, use the take-home pay calculator.
<h2 id="checklist">Your first-year contractor checklist</h2>
- [ ] Decide your structure: sole trader or limited company.
- [ ] Register with the right body: Self Assessment (sole trader) or Companies House (company), on time.
- [ ] Register for Corporation Tax and PAYE if you've formed a company.
- [ ] Open a dedicated business bank account.
- [ ] Check the IR35 status of each contract before you sign.
- [ ] Set up bookkeeping software and a system for receipts.
- [ ] Raise compliant, numbered invoices.
- [ ] Open a separate pot and set aside money for tax with every payment.
- [ ] Watch your rolling turnover against the £90,000 VAT threshold.
- [ ] Diarise the 31 January and 31 July tax dates, and the 5 October registration deadline.
- [ ] Check whether Making Tax Digital for Income Tax applies to you from 6 April 2026.
Starting out as a contractor and want it set up right? Book a free call with a Zmartly accountant. We'll help you choose your structure, register on time, and keep your first year compliant. Talk to a Zmartly accountant.
FAQs
Do I have to set up a limited company to become a contractor in the UK?
No. You can contract as a sole trader, which is simpler to run. Many contractors choose a limited company because agencies and clients often require it, and because a salary-and-dividends mix can be more tax-efficient at higher day rates, especially on outside-IR35 work. The right choice depends on your contracts and income.
When do I need to register with HMRC as a new contractor?
If you're a sole trader, you must tell HMRC you need to file a Self Assessment return by 5 October following the end of the tax year in which you started, once your income passes the £1,000 trading threshold. If you form a limited company, you register with Companies House first and usually register for Corporation Tax within three months of starting to trade.
What does inside or outside IR35 mean for a contractor?
Outside IR35 means you're genuinely in business on your own account, so normal company tax rules and the salary-plus-dividends approach apply. Inside IR35 means the engagement looks like employment, so Income Tax and National Insurance are deducted broadly as if you were employed. Your status affects your take-home pay, so check each contract before you sign.
When does a contractor have to register for VAT?
You must register for VAT once your taxable turnover exceeds £90,000 in a rolling 12-month period (the current threshold from 1 April 2024). You can also register voluntarily below that. Track your turnover monthly so a busy spell doesn't push you over without you noticing.
How much tax should I set aside as a new contractor?
There's no single percentage, because it depends on your structure, profit level and IR35 status. The safe habit is to move a fixed slice of every payment into a separate tax pot as soon as it lands, so the 31 January bill is already covered. Running your figures through a take-home pay calculator gives you a realistic target.
