Here we go! The age old question. To be, or…
When embarking on the path to self-employment, one of the key decisions you’ll need to make is the type of business structure you want to operate under.
Two of the most common options are running a limited company or operating through an umbrella company. Each structure has its own advantages and disadvantages, which can impact everything from the amount of tax you pay to the amount of administrative work required.
Let’s break down the differences.
Don’t have time? Here’s the wrap-up of this article in less time it takes to eat a taco 🌮
▪ Limited companies provide full control, greater tax efficiency, and reduced personal financial risk but come with more administrative responsibilities.
▪ Umbrella companies offer simplicity and less admin work but come at a higher tax cost and fewer tax-saving opportunities.
▪ Limited companies are ideal for long-term contractors and freelancers; umbrella companies are better for short-term projects or those who don’t want to deal with the complexities of running a business.
▪ If you’re operating inside IR35, your take-home pay will likely be similar whether you work through an umbrella company or a limited company.
▪ n.b. Stay Sharp, Stay Savvy and Keep Winning.
Limited vs Umbrella Companies. Who Will Win?
1- What is a Limited Company?
A limited company is a business structure where the company exists as a separate legal entity from its shareholders and directors.
It offers limited liability, meaning the personal assets of the company’s owners are protected in the event of financial issues. This setup provides more control over your finances, allowing for potential tax savings through dividend payments and expenses.
Benefits of a Limited Company:
▪ Tax Efficiency: With careful planning, you can pay yourself through a combination of salary and dividends, reducing your tax bill.
▪ Expense Claims: You can claim back a wide variety of business-related expenses, reducing taxable profits.
▪ Limited Liability: If the company incurs debt, your personal assets are generally protected.
▪ Credibility: A limited company can present a more professional image, potentially attracting more clients.
Downsides of a Limited Company:
▪ More Admin: You’ll have to file company accounts, annual returns, and manage payroll.
▪ Accountancy Costs: Hiring an accountant becomes almost a necessity to stay compliant.
▪ Public Information: As a limited company, your financial details are published on Companies House.
2- What is an Umbrella Company?
An umbrella company acts as an intermediary between a contractor and the client, effectively employing the contractor. The umbrella company handles payroll, tax payments, and administrative tasks, meaning less paperwork for you, but at the cost of lower take-home pay.
Benefits of an Umbrella Company:
▪ Simplicity: Less administrative work and no need to worry about tax returns or filing accounts.
▪ Employment Benefits: You’re technically employed, so you receive benefits like statutory sick pay and holiday pay.
Downsides of an Umbrella Company:
▪ Higher Tax: You’re taxed as an employee, meaning no dividend payments or expenses to reduce your tax bill.
▪ Service Fees: Umbrella companies charge fees, usually deducted from your pay, eating into your earnings.
3- Limited Company vs Umbrella Company: Key Differences
Control & Flexibility
▪ Limited Company: You have full control over your business, how you manage your finances, and which clients you work with. You can also build and grow your business over time.
▪ Umbrella Company: The umbrella company handles most of the admin, but you have less control over how you’re paid and the overall direction of your business.
Taxation
▪ Limited Company: You have the ability to optimise your income through dividends and expense claims, offering significant tax advantages.
▪ Umbrella Company: You’re taxed like an employee, meaning no opportunities for tax efficiency. PAYE deductions are taken directly from your earnings.
Suitability
▪ Limited Company: Best for long-term contractors, freelancers, or anyone planning to work on multiple projects and clients.
▪ Umbrella Company: Ideal for those new to contracting or those who want a short-term solution without the need to set up a limited company.
4- What If You’re Inside IR35?
IR35 legislation affects whether contractors are considered truly self-employed or essentially employees in the eyes of HMRC. If you’re caught inside IR35, your tax liabilities increase as you’ll be taxed like an employee.
▪ Limited Company: If you’re inside IR35, you’ll pay income tax and National Insurance just like an employee, reducing the benefits of a limited company setup.
▪ Umbrella Company: Given that you’re already treated as an employee, operating through an umbrella company might make more sense, as it offers a simplified solution without needing to worry about IR35.
5- Which is Right for You?
Ultimately, choosing between a limited company and an umbrella company depends on your long-term goals and how involved you want to be in managing the financial and administrative aspects of your business.
Go Limited IFF (if and only if)
▪ You plan to work on multiple long-term projects.
▪ You’re looking to maximise your earnings through tax savings.
▪ You don’t mind the extra admin and are in it for the long haul.
Go Umbrella IFF (if and only if)
▪ You prefer simplicity and less paperwork.
▪ You’re only contracting for a short time or are unsure if freelancing is right for you.
▪ You’re happy to forgo some tax benefits for employment perks like sick pay and holiday pay.
Conclusion: Limited or Umbrella – What’s Best for You?
Both structures have their place, and the best choice depends on your personal circumstances. A limited company offers flexibility, tax benefits, and control, making it ideal for long-term contractors looking to grow their business.
In contrast, umbrella companies provide a simple, hassle-free way to test the waters of contracting or freelancing, albeit with fewer financial benefits.
If you’re not sure which structure is right for you, consider your long-term goals, how much control you want, and whether you’re comfortable with handling the administrative load of running a business.
OMB Connect is here to help you figure out the best structure for your business and ensure you remain compliant with all necessary regulations.