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Deciding between forming a limited company or signing up with an umbrella company is an obstacle all contractors face at some point in their careers. It is important to make an informed choice as it can influence how much pay you take home. Both business models have their pros and cons, which are essential to understand and weigh up to ensure you make the best decision for yourself and your situation.
Umbrella Companies
If you choose to join an umbrella company, you will essentially work as an employee for them. This can be ideal for newer contractors trying things out, or for people who would prefer to get on with their work without dealing with the administration that comes with it. Additionally, you can operate without needing to worry about your status under the IR35 regulations.
With an umbrella company, your payment will be only in the form of a salary, in contrast to limited companies, making this option less tax efficient. As a trade-off, you will receive your pay with little input required on your part – you only have to submit the hours worked and expenses incurred during your contracts directly to the umbrella company. You will then receive a payslip with your PAYE salary, with any necessary deductions made, like tax and National Insurance.
Advantages
- Working with an umbrella company is a low-risk and low-cost way of contracting, which can be especially useful to beginner contractors looking to test the waters. Other than signing up for the umbrella company of your choice, there is no company set-up or registration, unlike starting a limited company. Once you have signed up, you can get started with contracting.
- As you are a company employee clearly paying tax and National Insurance, there should be no issues regarding your position under IR35 regulations.
- You will have the administration side of contracting handled for you, including payroll and tax contributions. As you are not a company director, you will not be obligated to provide tax returns and financial accounts.
Disadvantages
- You give up a lot of control over your finances, as the umbrella company handles them. There can be a long chain between your pay leaving your client and reaching your bank account, which may result in delays. This chain can be especially vulnerable in the event your umbrella company is financially unstable – you risk losing any money held by the company if it fails.
- Working with an umbrella company is a less tax-efficient option. If you were to set up a limited company, you would receive your payment in two separate forms: salary and dividends. This could result in paying less in taxes, which may not be the case with an umbrella company, where you are paid solely in the form of a salary.
- Ultimately, the responsibility of your tax affairs is on you. You are, therefore, responsible for finding a legally compliant umbrella company that abides by tax regulations. Some umbrella companies will cut corners, then offer higher returns in the hopes of drawing more clients. If these companies are deemed to be tax avoidance schemes, you as a contractor would be liable for any unpaid taxes and possibly fines. If you are unsure how to find a compliant umbrella company, consider contacting the FCSA for professional advice.
Limited Companies
Should you choose to establish a limited company, you would be the director of your own business, rather than an employee of another. This means you have access to certain tax benefits and control over how the business operates, but also all the responsibilities and obligations that come with it.
Unlike an umbrella company employee, your payment will be in the form of both a salary and dividends, if you decide to extract those funds from your company. The tax you would pay on these earnings is subject to how much your company earns and how much you pay yourself. By choosing this method, you can save on taxes and National Insurance, though be sure to consult an accountant for expert advice on how you can make the most of these benefits.
Advantages
- Choosing to operate as a limited company offers you the most tax benefits, making it the most efficient option from this perspective.
- You retain control over both your finances and exactly how you work. The supply chain is not nearly as long, meaning you do not subject yourself to the same risks as you would with an umbrella company. Additionally, you have control over the company finances, which both decreases risk and allows you to choose the direction the company goes in. Limited company business finance is readily available if additional resources are required to take the company forward.
- As you are the company director, you can tailor things to your life situation, taking on as much or as little work that suits you.
Disadvantages
- In exchange for control over your company and affairs, you will have a series of obligations to the HMRC and Companies House, which will likely result in fines if not met. These obligations include the financial accounts of your company and meeting your tax deadlines.
- In contrast to an umbrella company employee, you will be responsible for your company’s administration and day-to-day management. You will have to keep records of your finances and operations, and perform the paperwork processing yourself.
- You will be responsible for ensuring you abide by the IR35 legislation. Essentially, you will need to be able to prove that you work as your own entity and are not disguising your employment status. If you are found to be in breach of this legislation, you could be subject to heavy fines and higher taxes.
Conclusion
There are certainly ups and downs for both methods of contracting, with the ultimate decider being your personal situation. If you are new to contracting and would prefer a low risk testing ground, choosing an umbrella company could be the ideal solution for you. Alternatively, a more veteran contractor looking to maximise take-home pay may prefer a limited company, provided the administration is not off-putting. Hopefully, the information in this article is enough for you to make an informed choice. If you have any questions, or if anything is unclear, do not hesitate to contact us.
You may also like: Ultimate Guide When Running Your Own Contracting Business
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