2021 is the year we will see huge changes rolled out to IR35 legislation as it will be extended to the private sector. Naturally, many limited company contractors are considering their options in light of this, with many instead looking to work with an umbrella company.
If this is the case for you, it’s important that you do your research on limited company vs umbrella, so you can be sure you’re making the right decision.
To help, in this guide, Umbrella Broker looks at limited company vs umbrella, outlining the key differences and the advantages and drawbacks of each, so you can get on the right path in 2021.
Option 1: Umbrella Company
The first option for contractors is to work under an umbrella company. Umbrella companies are usually considered an easy, hassle-free way to working.
An umbrella company will employ the contractor. The contractor still has the freedom to choose which contracts they work on and when, however they also receive employee benefits.
The umbrella company will pay the contractor a salary, work out and deduct their tax through the pay-as-you-earn (PAYE) system, process their invoices and give them statutory benefits including holiday pay, sick pay, maternity/paternity leave and a workplace pension.
In exchange for these services, the contractor pays the umbrella company a fee.
Although this is an additional cost to contractors, it is worth noting that the umbrella company fee is considered a legitimate expense by HMRC and therefore can be deducted from your salary before it is processed through PAYE.
Many contractors favour the umbrella company route over limited company as it offers them the freedom of being a contractor and being able to source and secure their own work, coupled with the security and benefits of employment.
That’s what contracting through an umbrella company involves, now let’s look at the second option.
Option 2: Limited Company
The other option for contractors is to operate through a limited company.
Here, rather than being an employee, the contractor will be self-employed and must set up their own limited company.
Rather than paying tax through PAYE like an umbrella contractor, limited company contractors will be required to file for self-assessment and pay tax after they have received their fee from the client. It is worth remembering that self-assessment can often be tricky and complex, so many limited company contractors instead opt to use the services of an accountant to help.
To ensure they have enough money to cover their tax bill at the end of the year, limited company contractors must keep a portion of their earnings aside for this.
What’s more, a limited company contractor is responsible for setting up and running a business, taking on all tasks associated with this, such as admin, paperwork and invoicing. This can take up a lot of a contractor’s precious time and energy.
Finally, being self-employed, limited company contractors will not receive statutory benefits like umbrella company contractors do. So, if they should unexpectedly fall ill, or even just want to take a well-earned break, they will have to cover the costs of doing so out of their own pockets.
Other considerations: IR35
Another factor that will have a big impact over whether a contractor chooses to operate through an umbrella company or limited company is IR35.
IR35 originally applied merely to the public sector, however, as of April this year, reforms will be made to the legislation which will mean that it will also apply to the private sector. This will badly impact the thousands of limited company contractors operating in the private sector and is the reason many are now considering the umbrella company route.
So, what is IR35 and how will it impact you?
IR35 was initially set up to stop self-employed workers like contractors from operating as employees but enjoying the tax and National Insurance benefits of being self-employed.
IR35 made it the responsibility of the client and not the contractor to deduct the contractor’s tax and National Insurance contributions before they were paid their fee. This led to thousands of contractors being wrongly classified under the legislation, meaning they have ended up paying PAYE tax contributions when they did not need to.
What’s more, it is predicted that many larger clients will stop using the services of limited company contractors altogether.
Clearly, this is a major drawback of working through a limited company. As April draws ever closer, many contractors are now looking to change how they operate in favour of working under an umbrella company under which a contractor is exempt from IR35 legislation.
