When contracting, there are two ways in which you can conduct your work:
- Operating as a limited company, in which you set up a company yourself and become the director, responsible for business operations and following the relevant laws.
- As the employee of an umbrella company, where you fill in timesheets, the client pays the umbrella, and then they deduct tax and NI and (after deducting a small fee) pay you.
We look at the main differences between umbrella and limited, and what it's like operating through both.
Contracting through a PAYE (Pay As You Earn) umbrella company is generally seen as the first stop for new contractors, as you have less responsibility when it comes to paying tax and NI.
When completing work for a client you fill out timesheets, showing how long you've worked and for how many days. Once that's submitted, and the client agrees that it's accurate and the work is complete, they send the funds to the umbrella company.
The umbrella company does the hard work of paying the tax and NI due, and (after deducting their fee) send what's left to you.
With this option there's less stress for you, as you don't need to sort out your own tax after every completed job. Many people choose the umbrella route when first starting out, as you don't need to manage as much admin while you learn the ropes.
Many people also transition into contracting from full-time employment - so filling out timesheets and receiving only your take-home pay is a familiar scenario.
Limited companies are different in many ways to umbrellas, as you're setting up your own company, with you as a director. You take on all the responsibilities involved, ensuring that the company complies with all relevant business legislation.
You'll be fully in charge of your accounts, salary and tax obligations, and if you accidentally submit an incorrect tax return, the blame would be on you. As you would expect, many people don't take the limited company route until they've had experience of the contracting world.
Many contractors who go the limited company route get in touch with specialist contractor accountants, who look over their personal finances and accounts to ensure that nothing gets forgotten.
What about IR35?
Even if you do hire a contractor accountant, you need to be wary of IR35 - legislation brought in to catch out ‘disguised employment'. This is where a contractor acts as a full-time employee of a client's company, yet claims to be a contractor to gain tax benefits. If caught by this, even unknowingly, you face losing those benefits.
It's vital to do your own research into IR35 legislation if you work as a contractor, and understand how it may affect you.
Copyright © 2018 Article was made possible by Brookson, specialist contractor accountant.