Sole trader, Umbrella or Limited company?
What is best for a start-up?
It is a freelancer’s big question. Each approach is different, this article looks at the current situation.
Which is the best business structure for you?
Sole trader equals self-employed. Profits equals income after you’ve paid tax on them. You are personally responsible for losses. You must follow rules on running and naming your business.
A limited company is an independent legal entity – even for a single person. As director, you’re responsible for all business decisions. Important, remember the company’s assets and liabilities are separate from your own finances. As director/shareholder, pay yourself salary and dividends from profits. The company must make annual returns and file accounts with Companies House/HMRC – your responsible for this.
Umbrella companies are intermediaries between freelancers and end-clients. The umbrella handles the admin for tax/payroll and you’re an employee of the umbrella. The umbrella collects your fees, deducts tax, national insurance and admin fees, and pays you the balance.
What Are The Advantages?
Less paperwork: Both sole traders and directors of companies submit personal self-assessments to HMRC. Limited’s also submit extra paperwork (Corporation Tax, Annual Accounts, VAT returns if registered). Miss deadlines and HMRC will demand fines/penalties. Sole traders avoid the headache.
Simpler accounts: The accounting process is simpler for sole traders. Less paperwork, fewer expenses to account for and accountants typically charge lower fees.
Privacy: Limited companies must share some information in public such as annual accounts filings and directors/shareholders names. Sole traders don’t have to do this.
Limited liability: Your personal assets are safe from creditors.
Potential for greater profitability: As a sole trader, all profit made is income. You pay income tax and National Insurance Contributions (NIC) based on the current tax year thresholds.
For 2017/18 tax year, effective tax rate would be 29% on profits above £11,500 (basic rate taxpayer). The rate increases as you exceed higher income thresholds. As a limited company you pay Corporation Tax (19%) on company profits, and pay yourself via dividends/salary.
Advantage – you minimise income tax (PAYE) and NIC. Additional payments (dividends) will be taxed from 7.5% if you’re a basic rate payer.
Limited’s can claim more business expenses: Deduct from profit and reduce tax. Ask your accountant about allowable expenses to avoid problems with HMRC.
Borrowing power: As a sole trader, you rely on personal credit ratings to borrow to grow your business. A limited has its own credit rating, an advantage for those with lower credit ratings.
Simplicity: As a freelancer or contractor working under an umbrella company, you’ll be afforded a much simpler way of doing business. The paperwork is done for you. You receive your pay, payslip and calculations.
Reduce Risk: Sole traders sometimes get caught out with unexpected tax bills. An umbrella company removes this problem.
Flexibility: Working via an umbrella company is an option if you’re unsure about contracting or freelancing long-term.
It is still far from an easy decision in making this decision. If you need some help, get in touch and we would be happy to discuss more with you.