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Taking that leap from employee to contractor means there will be all sorts of new tasks to take care of, including what’s seen as the most daunting of all: your business’ financial responsibilities. Your operating structure largely determines this, but how can you tell which one is best for you? 

We’ve made it simple by outlining each of the most common structures, as well as their advantages and disadvantages, so that you can make an informed decision when choosing how to register your business.

Option 1: Limited company

This structure involves incorporating a private company on Companies House. You’ll become a director (or need to appoint one), be required to submit a Self Assessment tax return, and also need to issue invoices from a registered company name and address.

Limited company: advantages

The limited company is legally responsible for any losses, meaning any personal assets will be protected if the company is dissolved. On top of this, running a business in this way is generally more tax efficient, increasing your take-home pay. This includes offsetting expenses, with more of a variety to claim on compared to umbrella companies.

There’s also no need to change the operating structure if you switch contracts, regardless if an assignment is fixed, short-term, or classed as falling inside or outside IR35, meaning you won’t have to go through the process of setting up time and time again.

Limited company: disadvantages 

Whilst there are arguably more rewards to be reaped from choosing the limited company route, there’s also more work involved. You may find that you’ll need an expert accountant to assist you in terms of maximising your tax efficiency, preparing and submitting financial statements and tax returns, and other bookkeeping services. You’ll also need to keep on top of what information you will need to submit and how, especially with Making Tax Digital due to come into force.

Additionally, there will need to be a decision around whether your contract is inside or outside IR35. For public sector assignments, the public authorities determine this. Currently, the IR35 status of private assignments is decided by the contractor. A potential disadvantage is that, if you stop contracting during the accountancy period, you won’t be able to make the limited company dormant until the end of that period.

Option 2: Umbrella company

Operating under an umbrella company means you’re still a contractor, but become their employee. They will provide you with the legally required employment rights. This structure is generally used for agency contractors working on fixed-term assignments.

Umbrella company: advantages

An umbrella company takes much of the administration work off your plate, dealing with National Insurance contributions and Income Tax, and taking responsibility for the directorial duties. As an employee, you also won’t need to submit a Self Assessment. All you’ll need to do is register, and submit timesheets and expenses to the agency or umbrella company when relevant.

This route is particularly beneficial if you’re planning to go back to permanent work at some point. If you’re unsure what the future holds, operating under an umbrella company gives you the peace of mind that you won’t have to pay any fees if you stop contracting. An additional benefit is that you’ll have employment rights, such as statutory sick pay and holiday entitlement.

Umbrella company: disadvantages

It’s almost guaranteed that this route will increase your tax liability; although the company will manage it on your behalf, you’ll be required to pay National Insurance contributions and Income Tax. Also, there are less expenses that are classed as allowable. If you’re planning to contract for the long term and want to be seen as credible, then the lack of a business name may work against you.

Another potential disadvantage is choosing the wrong umbrella company. Unfortunately, there are ones out there that aren’t compliant, offering contractors higher take-home pay than is legally possible. This means you’ll be underpaying tax and could be investigated by HMRC, so choosing a trusted company is imperative.

Option 3: Sole trader

Becoming a sole trader requires you to submit a Self Assessment, but you don’t have to form a limited company. You simply register as a business, and can even trade under your own name if you wish.

Sole trader: advantages

Compared to a limited company, there’s much less accountancy work to take care of. This can be simpler when you initially set up and are unsure of whether you’ll be contracting long term. If you do decide to stop contracting or switch to another operating structure, this can be easily changed.

Being the exclusive owner of the business, you are entitled to all profits after tax, meaning you can often retain more than if you were to opt for an umbrella company. On top of this, sole traders’ data isn’t publicly available on Companies House like limited company information is. This can be particularly beneficial if you work in a sector where you’re concerned about your privacy.

Sole trader: disadvantages

The major disadvantage of operating as a sole trader is that, due to the lack of legal distinction between you and the business, you’ll be liable for any losses made. This means that your personal assets could potentially be affected.

You also can’t be an agency worker if you’re a sole trader. Agencies would require you to switch to the umbrella structure or set up a limited company. If you don’t do this, the work available to you may be limited, resulting in you spending more time sourcing your own work.

Which solution is best – limited company, umbrella company or sole trader?

Ultimately, the operating structure you decide upon will depend on your situation. There is no good or bad structure, and no right or wrong choice. If you are struggling with selecting the best route, why not speak to a member of the team and we can assist you?

It’s key to get a clear picture of your circumstances in order to suggest the most suitable option, which is why we take the time to understand you and your business. We provide support for all three structures, so no matter which route you choose, we can help. Our all-inclusive Accountancy Package is designed specifically for sole traders and limited companies, and Gorilla Payroll can act as your employer if you opt to set up under an umbrella company.

You can have trust in us – we’re ranked as the number one accounting company on Trustpilot, which is based off customers’ reviews. This is due to the fantastic service we offer, which includes our Client Service Guarantee. The guarantee means that if you contact us before 3pm, we will respond the very same day. If this doesn’t happen for any reason, we’ll pay you £50 compensation.

If you’d like more information about how we can help you, get in touch to speak to one of our experts today.