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It’s the self-employed’s eternal quandary - to remain a sole trader or form a limited company? Or perhaps it’s better to work via an umbrella company and leave the admin to someone else?

There are differences in each structure, particularly when it comes to tax issues. This article will help you understand each option and decide which is right for you: sole trader, limited company or umbrella company.

Which business structure is right for you?

Limited company

A limited company is a separate legal entity that you can form to run your business – even if you’re a one-person business. As a director, you’re responsible for any legal and financial decisions the company makes. The company’s assets and liabilities are completely separate from your own personal finances.

If you decide to set up your own limited company, you’ll be a director and a shareholder of the business. You can be paid a salary and/or dividends from the company’s available profits - of course, choosing the latter means working out how much dividend tax you'll need to pay, once it's time to file your first return. The company must make various annual returns and file annual accounts with statutory bodies such as Companies House and HMRC. It’s your responsibility as a director of the company to ensure this happens. There are a number of other deadlines and responsibilities that we explain in our handy article.

Self-employed/ Sole trader

If you’re a sole trader, you run your own business as an individual and are self-employed. You can keep all your business’s profits after you’ve paid taxes on them. You’re personally responsible for any losses your business makes. You must also follow certain rules for running and naming your business.

Umbrella company

Umbrella companies act as intermediaries between contractors, their employment agency and the end client. The umbrella company deals with a lot of the administrative side of things, particularly in relation to tax and payroll; you’re an employee of the umbrella company.

When the end client pays your invoice or timesheet, the umbrella company will collect the income, deduct income tax and National Insurance Contributions (NIC), as well as an administration fee, and then pay the remaining amount to you.

Advantages of a limited company

Limited liability

As the company is a separate legal entity, your personal assets are protected. If your company needs to close or experiences financial difficulties, your personal assets cannot be taken from you to pay company debts.

Potential for greater profitability

As a sole trader, all of the profits made by your business are taken as income. You’ll pay income tax and National Insurance Contributions (NIC) based on government thresholds.

Through operating as a limited company, you’ll pay Corporation Tax on your company profits, and can pay yourself through a combination of dividends and salary (usually set at the primary threshold for National Insurance). This will minimise your PAYE (tax you pay on your earnings throughout the year) and NIC outgoings. Any further payments you make to yourself will usually be taken as dividends. We explain how dividends are taxed in our helpful article, as the rates are lower you’ll pay less in tax if you’re a basic rate payer.

You can also normally claim more business expenses through your limited company than as a sole trader, which includes business-specific items such as stationery and business cards, mileage allowance, business trips, employee mobile phones and meals bought while working away. It’s important you speak to an accountant about which expenses are allowable, as HMRC have strict rules about what can be claimed.

Any money you claim in expenses will be deducted from your company’s profit and will therefore not be taxed - you can review this using our personal income tax calculator.

Borrowing power

As a sole trader, you rely on your personal credit rating to borrow capital used to grow your business. A limited company can establish its own credit rating, which can support borrowing to invest in the business. This is good news for those individuals who don’t have the highest credit ratings.

Improved reputation/credibility

Confidence is critical in business, and a limited company has a veneer of professionalism which instils such confidence.

Some clients – large corporations and those in the financial sector especially – simply prefer to work exclusively with limited companies, but others flatly refuse to deal with unincorporated business. So, having a limited company can present new business opportunities that may not otherwise have existed.

Find out more about how to change from a sole trader to a limited company. You can also find out more about Crunch’s accounting service for limited companies.

Advantages of staying self-employed

Less paperwork

Both sole traders and directors of limited companies are required to submit a personal Self Assessment to HMRC, but those operating a limited company must also submit extra paperwork to regulatory authorities (Corporation Tax, Annual Accounts, VAT returns if VAT registered). Failure to submit returns on time usually results in significant fines and penalties. As a sole trader, you’ll avoid the headache of these returns.

Simpler accounts

The accounting process is much simpler for sole traders - there’s less paperwork, fewer expenses to account for and often fewer clients. As such, if you do have an accountant at this stage, it’s often less expensive than it is for limited companies.

Privacy

Legally, limited companies must be transparent and share certain information with the public, such as filing annual accounts and stating the names of directors and shareholders on public registers at Companies House. As a sole trader, you don’t have to provide this information to Companies House.

Find out about Crunch’s accounting service for sole traders.

Advantages of an umbrella company

Simplicity

As a freelancer or contractor working under an umbrella company, you’ll be afforded a simpler way of doing business. The paperwork, which includes the deduction of income tax and NIC, is done for you. You’ll receive your pay, alongside a payslip and a breakdown of how this is calculated.

Sole traders sometimes get caught out with unexpected tax bills because they haven’t put their tax aside throughout the year. Working via an umbrella company removes this potential as you receive a salary as an employee of the umbrella company.

Flexibility

Working via an umbrella company can be a good option if you’re not sure about committing and contracting or freelancing long-term. It’s free from the stress of running your own company, although this does mean you work as an employee.

Still confused?

It’s far from an easy decision, but hopefully, this article has helped clear a few things up. If you need some more help, give your friendly advisors a call on 0333 920 2266, or to see what the financial benefits might be for each option you can work out your salary after tax with our simple take-home pay calculator.

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Lucinda Watkinson
Head of Accounting
Updated on
November 1, 2022

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