Sole trader, limited or umbrella? What is the best option?

Working as a contractor or freelancer allows you to choose the projects that you work on, enhance your skill set and work more flexible hours.

As a contractor you don’t have an employer to organise your tax and national insurance contributions for you, so you need to decide on a way to operate, which will ensure that all your financials are correct and dealt with accordingly. The best route for you will depend on your future plans, salary and what you deem most important. So, what is the difference between a sole trader, umbrella and a limited company?

umbrella companySole trader

A sole trader is someone that owns their own business entirely. To operate as a sole trader you will need to register your business with HM Revenue and Customs (HMRC) and complete an annual self-assessment tax return. As a sole trader you have unlimited liability, which means that if your business was to encounter any financial problems, then you would be liable and in a worst case scenario your personal assets would be at risk. Contractors may find it difficult to operate as a sole trader because they do not have the same protection as limited company contractors, and some companies may even have a stipulation that they will only employ contractors that operate through a limited company.

Umbrella company

If you decide to work under an umbrella company then they will take care of the financial side of things for you. The umbrella company will collect your earnings from your client and deduct income tax and national insurance through the PAYE system, before paying it onto you. Employing the services of an umbrella company is the most expensive way to operate as you will be charged full tax in the same way that a full-time employee would be, in addition to this the umbrella company will also charge a fee for their services, which will be deducted from your pay.

When it comes to choosing an umbrella company, be aware that the claims made by the companies will vary and if something seems too good to be true, then it probably is. If you work under an umbrella company and you were to be investigated by HMRC then it is you that is liable for any discrepancies, not the umbrella company. It has been claimed that some umbrella companies will add on a daily un-receipted expense for their contractors and then in the small print it will state that although receipts aren’t needed to process expense claims they will be required if HMRC ask to view them. To stop yourself getting in hot water make sure that you choose an umbrella company that does not claim to provide the impossible.

Limited company

Limited company ownership is a popular way for contractors and freelancers to work because it allows you to maintain control over your company with low personal financial risk. Working through a limited company will generally be the most tax efficient way of working and limited company owners are able to claim on a wide range of expenses. As a limited company owner, you the director are considered a separate entity from your limited company, which means that all debts are company debts and your personal assets are not in jeopardy.

All three of these options come with positives and negatives, and deciding on the best route will depend on your line of work, salary and how long you plan on working on a contract or freelance basis.

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