Sole Trader vs. Limited Company vs. Umbrella Company: What’s best for you?

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Like any other job or business, freelancing also requires good decision-making skills. This becomes useful especially when freelancers face the dilemma of choosing whether to continue operating as a sole trader or creating a limited company. They may also choose to take their hands off administrative tasks and opt to run an umbrella company.

It is important to determine early on which business structure best suits your approach and resources to make sure you survive come tax season. Here, we will let you have a good look at the three business options and, hopefully, help you decide.

Which business structure is right for you?

Limited company

If you work solo as a businessman, you can create a limited company and run it as the company’s director. You will then be in charge of making decisions on legal and financial matters. However, it is important to remember that, although you are the director, the limited company remains a separate legal entity with its own assets and liabilities. This means that there is a clear boundary between your personal finances and that of the business.

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By running a limited company, you will earn a salary or dividends as its director and shareholder and will be responsible for filing the company’s annual accounts with HMRC and register with Companies House.

Sole Trader

As a sole trader, you are considered self-employed and will operate your business as an individual. After taxes, you share the profits earned from the business, but you will also be liable for any business losses. As the operator, it is also your responsibility to know the rules as you run and name your business.

Umbrella Company

An umbrella company handles a business’ administrative tasks including tax and payroll obligations. As a type of business structure, an umbrella company mediates between the contractor, the employment agency, and the end client. You are en employee and every time a client issues a payment for your invoice or timesheet, it is the umbrella company’s role to collect the income and pay you after tax and NICs due have been deducted.

Advantages of Going Limited

Limited Liability

Having limited liability is an advantage for limited companies in terms of financial crises. In the event your company suffers losses, you will not be held legally accountable and cannot be forced to use your personal assets to cover for these losses. There is protection on your part simply because you and your company are considered separate entities.

Potential for Greater Profitability

When operating as a sole trader, your income is equivalent to the company’s profit. Since income taxes and National Insurance Contributions are based on income, higher profits mean higher tax and NIC dues.

This is not the case for directors of limited companies whose incomes come in the form of salaries and/or dividends, which usually fall under the primary threshold in National Insurance Contributions. Earnings set at the primary threshold incur no NICs. This also equates to reduced taxes paid on earnings for one financial year (PAYE). Limited companies are also required to pay Corporation Tax which is equivalent to 19% of the company’s profits.

Another opportunity for profitability is the privilege to claim business expenses during business-related trips, purchases, mobile phone charges, and meals. Businesses expenses can be charged to the company’s profit, exempting these from taxes. However, HMRC has specific guidelines on the expenses allowed, therefore, it is best to speak to an accountant before filing a claim.

Borrowing Power

In terms of borrowing capital, sole traders usually have to establish a good personal credit score in order to gain support for their business. Limited companies do not have this problem as it is easier for them to build credit ratings that are attractive to investors. If an individual does not have a good credit standing, operating a limited company is often the best choice.

Improved Reputation or Credibility

Clients have an eye for good investments, making confidence and credibility important. Most investors choose to do business with limited companies because of the image of professionalism and confidence that goes with this business structure. This simply means that limited companies attract business opportunities more than sole traders do.

Advantages of Staying a Sole Trader

Less Paperwork

Although a Self-Assessment is required for both sole traders and limited companies, the latter usually involves more paperwork. Apart from documents submitted to HMRC, limited companies are also required to file Corporation Tax, Annual Accounts, and VAT returns if the business is registered for VAT. There are corresponding penalties if returns are not filed on time, things that sole traders are spared from.

Simpler Accounts

In addition to having less paperwork, there are also fewer expenses involved when operating as a sole trader. Since sole traders often work with less clients, there are also less accounting work required, resulting to accountants charging less.

Privacy

Sole traders are not required to register with Companies House nor publicly register business information. Limited companies, on the other hand, file annual accounts and are required to submit the names of their directors and shareholders to public registers. In other words, sole traders enjoy more privacy because their business details are kept confidential.

Advantages of an Umbrella Company

Simplicity

Among the three business structures, the easiest is to work under an umbrella company. Paperwork related to tax are very tedious to do. This is why sole traders often have to deal with problems with their tax bills. When working under an umbrella company, income tax and NIC filings are already done for you, so is payroll processing. Payslips with a breakdown of the calculation are given to you (the contractor or freelancer) when you receive your salary as an employee of the umbrella company.

Flexibility

Flexibility is another advantage of working as an employees of an umbrella company. Not only can you steer clear of the stress of operating your own business, but also, you may have other plans and may consider ceasing working as a contractor or freelancer. Working for an umbrella company will save you from any type of commitment.

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