Every contractor needs to know what their options are when it comes to how they operate. After all, there are several routes available to contractors, from opening and running their own limited company to working through an umbrella company, each with its own advantages and drawbacks.
To help contractors understand what's best for them, Umbrella Search have put together this guide explaining everything you need to know about limited companies, from how they work to the pros and cons of this option.
Limited companies for contractors
As we have already mentioned, there are a number of ways that contractors in the UK can operate – one of which is through a limited company.
Here, the contractor sets up their own registered company with Companies House for a small fee.
This means that rather than being a sole trader, the contractor works self-employed through their own limited company.
Benefits of working through a limited company for contractors
Freedom and flexibility
The main benefit of working through a limited company for contractors is that it gives them total freedom and flexibility due to the fact that they are self-employed and therefore work for themselves and not an umbrella company or a PAYE agency.
However, although this sounds great, it is worth noting that if the limited company grows and takes on shareholders and other directors, contractors will have to answer and be accountable to these other individuals, so this only remains true when the limited business has one director.
As contractors that operate through a limited company are self-employed they can usually pay themselves in more tax-efficient ways through a mixture of taking a salary and dividends. This usually works by the contractor taking a small salary and topping their income up with dividends which are taxed at a lower rate. Read more about dividends and the rate they are taxed at in this government guide.
Although this can be a great option for contractors that can afford to take a lower monthly salary, it is worth noting that some contractors may struggle with cashflow issues with this route.
Drawbacks of working through a limited company for contractors
Although there are a couple of advantages to working through a limited company for contractors, there are also several drawbacks.
Tax can be tricky
Although some contractors may benefit from paying themselves in a slightly more tax-efficient manner, there are several duties the contractor must shoulder when it comes to tax. For example, limited company contractors are responsible for filing their own tax returns which can often be tricky and time-consuming.
Unlike umbrella contractors, who are paid through the PAYE system in which their tax is calculated and taken off their salary each month, limited company contractors are off-payroll workers who must instead file an annual self-assessment. This not only requires a lot of time and energy, but it also means that throughout the financial year, contractors must ensure they are setting enough of their income aside to cover the end of year tax bill.
What's more, limited company contractors will also have to file a Company Tax return each year and will also be required to pay corporation tax on any company profits meaning an additional expense.
Such tax returns can often be complex and result in the majority of limited company contractors paying for and utilising the services of accountant, which comes at an another additional cost.
Another drawback to the limited company route for contractors is that they will have to take on the responsibility of running a business and deal with all the admin and paperwork that comes with this.
This includes contract-specific tasks such as invoicing the client and also tasks associated with running a business such as filing an annual confirmation statement.
Unlike umbrella company contractors who don't have to worry about business admin tasks due to the fact that they are not running their own business, those who contract via a limited company, have to do their own paperwork.
In contrast, the umbrella company will take care of paperwork such as invoicing the client and chasing payments, freeing up the contractor's precious time.
Every contractor will have heard of infamous IR35 legislation. In fact, one reason many contractors choose to operate through an umbrella company rather than a limited company is that it allows them to avoid getting caught out by the legislation.
Getting caught out by IR35 can be stressful and costly to contractors and thousands have ended up paying too much in tax as a result of the legislation, being wrongly classified as employees when they are in fact self-employed.
Contractors operating through a limited company must take the time and energy to guarantee that they are IR35 compliant to avoid running the risk of getting caught out or caught in lengthy and expensive investigations.
No statutory benefits
Another reason why so many contractors opt to work through an umbrella company rather than a limited company is that with this route they benefit from statutory benefits, which includes paid sick leave, holiday pay and maternity and paternity pay.
Limited company contractors, on the other hand, don't receive such benefits.
This means that if a limited company contractor falls ill, or even just wishes to take a well-earned break, they have to cover these costs themselves, as well as face a loss of income whilst they are not working.
Thinking twice about a limited company? Take the next steps with Umbrella Search
After finding out more about working through a limited company, you may want to join the thousands of other contractors across the UK who opt to work through an umbrella company.
If you want help finding an umbrella company that's just right for you, Umbrella Search is here to help.
At Umbrella Search we work closely with you to find an umbrella company that's the perfect fit for you, whatever your contractor requirements may be. To take the first steps to finding an umbrella company today, get in touch with our friendly team.