What’s the Best Business Structure for a Contractor?
Self-employed persons who work for firms on a temporary basis are known as independent contractors, consultants, or freelancers. Employing a contractor allows businesses to gain access to specialised skills, knowledge, and experience without having to hire someone full-time. This is frequently enticing.
If you want to work as a contractor, you’ll need to figure out what kind of legal structure you’ll require. It’s referred to as your “legal structure.”
The legal structure you choose has an impact on how much tax you pay, how you operate your business, and what records you must preserve. You essentially have three main options, as with most start-up businesses:
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- Operate as a sole trader
- Create a limited company (LTD)
- Form a partnership
As a sole trader, you can start your contracting firm
In terms of administration and tax, becoming a sole trader is frequently the simplest route into contracting. You don’t need to register with Companies House, so you won’t have to file yearly accounts with them, and getting started is simple.
You and your business, as a sole trader, are legally one and the same. Because there is no distinction between you and your firm, you are entitled to all profits after taxes.
On the other hand, any business debts or liabilities are your responsibility as well. If your contracting business runs into financial or legal difficulties, you are solely responsible for resolving the situation.
As a sole trader contractor, you must pay tax
As a sole trader, you must register with HMRC for Self Assessment and file an annual tax return. It’s critical to keep detailed records of your business income and spending in order to ensure that you pay the correct amount of tax (and claim all of your expenses!)
Keep in mind that any profit you make may be subject to fixed-rate Class 2 National Insurance contributions (NICs) as well as Class 4 National Insurance contributions. Our page on UK tax rates, thresholds, and allowances shows how much National Insurance self-employed people must pay based on their wages.
For contractors, what are the advantages of being a sole trader?
Many contractors prefer to work as sole traders since it is easier to get started and provides more flexibility. You’ll need to keep track of your gains and losses (bookkeeping) and file your Self Assessment tax return on time.
Are there any drawbacks to working as a contractor as a sole trader?
Because you are solely accountable for your firm, any debts or other liabilities must be paid out of your own pocket. If you don’t have the funds, this might put your home or other personal assets at jeopardy.
Some contracting organisations may refuse to engage with sole traders, which might have a significant influence on your ability to find work.
Working for a limited corporation as a contractor
Limited corporations are legal entities distinct from their owners and directors. You are not legally liable for the company’s obligations or liabilities, but any earnings remain the company’s property.
To begin trading, you must first register with Companies House as a limited company. Incorporation is the term for this process, which is explained in greater depth in the video below. To begin, a limited company must have at least one director and must file yearly accounts with Companies House.
What about limited liability partnerships?
You might choose to form a limited liability partnership (LLP). This provides partners with the benefits of restricted liability while yet allowing them to organise their internal structure as if they were in a traditional partnership.
Because LLPs are separate legal entities, the company is responsible for its own assets, debts, and obligations if something goes wrong. Each partner’s liability is limited to the amount they put into the business.
In theory, any business with two or more partners can form an LLP, although it’s most commonly utilised by professional firms, such as law firms.
The administrative burden of an LLP is similar to that of a limited company, so an accountant for contractors may be desirable (though not required by law).
The advantages of operating your contracting company as a limited corporation
The benefit of forming a limited company is that your responsibility is limited. It’s more expensive and time-consuming to register, but if something goes wrong, only the company’s assets can be taken, not the directors’ or shareholders’ personal assets.
It’s also frequently more tax-efficient. Many business owners serve as both directors and shareholders, earning a salary as an employee of the company and then receiving dividends. Read about the most tax-efficient pay for company directors in our post.
Another advantage for contractors is that, rather than functioning as a sole trader, forming a limited company might help your business appear more credible. Because many contracting organisations won’t work with single traders, becoming a corporation will help you find more work. It is also likely to be easier to raise capital and sell up.
What are some of the realities of running a business?
It is your obligation as a business director to ensure that the firm submits accurate tax returns and accounts to HMRC and Companies House each year. You’ll also need to file a Self Assessment tax return if you’re a company director.
You’ll need to register for Self Assessment on the Gov.uk website if you don’t regularly file a tax return. You’ll need to include information about your income as a director, as well as any other income, each time you file your tax return.
Creating a Partnership
Contractors can form a partnership to share the obligations, costs, and hazards of running a firm with others. It’s a straightforward and adaptable solution for two or more people to jointly own and operate a corporation.
You don’t have to register with Companies House, which cuts down on some of the paperwork. Rather, each partner works for themselves and then registers the partnership for Self Assessment.
Partnerships do not have the same legal status as limited liability businesses. They merely serve to connect two or more self-employed individuals, though partners can also be a limited corporation or another partnership!
Unless a formal agreement is set up that indicates differently, profits and gains are normally split between each of the partners.
Are there any drawbacks to starting a business as a partnership?
You must be very certain that you can trust someone before entering into a partnership with them. Even so, make sure you have a contract in place before you begin! This is because each partner is fully responsible for all obligations and responsibilities.
If the partnership gets into financial difficulties, creditors may be able to confiscate personal assets. It doesn’t matter if your partner racked up the debt and you didn’t; you’re still liable.
Partnerships, like sole traders, do not (typically) file public accounts with Companies House, thus they can be a bit of an unknown quantity. Other businesses may be hesitant to do business with you.
You may also find that dissolving your partnership is a time-consuming (and thus costly) process. Another argument for the importance of a thorough Cooperation Agreement that covers all areas of the partnership.
FURTHER READING: Accountants guide to starting up as a contractor