Limited or umbrella company. Which do you choose? Here's a brief rundown on the advantages and disadvantages of both.

So you have secured a contract for yourself and the big question that is asked by almost every new entry to the market is whether they should trade as a limited company or use the services of an umbrella company. The decision will have a huge impact on your personal tax bill so it is important to get it right.

Firstly, let me explain to those of you who are unsure of what an umbrella company is. It is essentially a payroll facility. The structure will be that of a limited company but could have as few as 1 or as many as 10,000 individuals working through it. If you chose to use an umbrella company, you’d become an employee of the umbrella company for the duration of your contract and will be paid as an employee with full tax and national insurance being deducted before you are paid your net salary.

Of course, if you operate through your own limited company, your business will ‘own’ your contract and get paid for the time you work and then it is up to you to pay yourself from your business with the support of a good accountant (hello!) to guide you through the process. But it will just be you that works through your company.

So how do you know which route to choose and what are the benefits of each? Let’s start with a few pros and cons for you to consider:

Pros

Cons

Umbrella

Instant Set upHigher tax bills
No Administration - Hassle FreeIn most cases, can't claim expenses
What is paid to you is yours to keepNo tax structuring opportunities
Fees only apply when you are contracting
May not need to register for self-assessment
Covered by Umbrella's insurance policies
Removes IR35 compliance concerns

Limited Co.

Tax efficient structuring opportunities Deemed self-employed for mortgage applications
Lower tax billsSet up process to go through
Can claim expensesHave to be registered for self-assessment
Prstuge of running your own businessIR35 considerations
Other income streams can be put through companyNeed to have your own insurance policies in place
Control over the cash paid to you by your agency/clientCompliance considerations with HMRC and Companies House

So as you can see there are a few things to consider. Our experience is that in helping you decide which way to go, there are a few important questions to consider. The critical factors to take into account in coming to a decision are as follows:

  1. Length of contract
    : If you have a contract of anything under 3 months, you’d probably be leaning towards using an umbrella company. Anything longer than 3 months and you’d be thinking about using your own limited company.
  2. Rate of Pay
    : The higher your rate of pay, the more beneficial the use of a Limited Company will be for you. Any rate of more than £15 / hour will bring the limited company into play. The higher your rate, the more obvious your decision would be to set up your own limited company.
  3. Your IR35 status
    : If your contract is deemed to fall under the off-payroll rules (known as IR35), then you would almost certainly be encouraged to use an umbrella company. If this is not the case, then it would make absolute sense to use your own limited company to run your contract through.
  4. Personal Preference
    : Sometimes, we will come across clients who simply want to use either an umbrella company or their own limited company irrespective of any other advice. So, at times, it is simply about the wishes of the individual.
  5. Multiple sources of income
    : If you have other income streams outside of your contract work, then setting up your own company should be strongly considered. Those multiple income streams, irrespective of the nature of the income, can be run through a company and you can take advantage of the tax planning opportunities.

Lastly, when assessing the ‘Limited v Umbrella’ option, it is important for us to give you a feel of what the two different avenues could mean to you in terms of taxes and take-home pay. So, let’s set out some parameters and then illustrate the differences in those numbers.

Those parameters (evaluated over the course of a 48-week working year):

  •   •  Contract Rate of £450 per day
  •   •  Monthly Train fare in getting to contract site of £250
  •   •  Subsistence claim of £5 per day
  •   •  Monthly Mobile Telephone bill of £40
  •   •  Monthly Broadband and office costs of £75
  •   •  Monthly Company Insurance cost of £40

So working through an umbrella company, the equation is really simple: Your income would be £108,000 (£450 / day for 5 days a week for 48 weeks a year) meaning your taxes deducted would amount to £43,813 with your take home pay being £64,187. Your taxes would be broken down as follows:

Contract Value: £108,000
Gross Salary: £95,950
Employers National Insurance: £12,050
Employees National Insurance: £5,883
PAYE Tax: £25,880
Take Home Pay: £64,187 (or 59.43% of contract value)

Working through a Limited Company, the equation would be different. With your gross contract value being the same (£108,000) and presuming you took every last penny from the business (which may not be tax efficient to do but we’ll stick to that to ensure we are comparing apples with apples), your total taxes deducted (company and personal) would be £28,995 with your take home cash amounting to £78,525. Again, this is broken down as follows:

Contract Value: £108,000
Less Claimable Expenses: (£14,692)
  -  Train Fares: £3,000
  -  Subsistence Claims: £1,200
  -  Mobile Telephone: £480
  -  Broadband & Office: £900
  -  Company Insurances: £480
  -  Salary Paid to Yourself: £8,632 (Note: This salary would be tax free)
Profits Before Tax: £93,308
Company Tax (19%): (£17,729)
Distributable Profit: £75,579

The £75,579 represents the amount that you could pay yourself as a dividend. Let’s presume that you paid all of this out to yourself, the total personal tax that you would pay on this would be £11,266. So your total take home pay would be made up as follows:

Tax Free Salary: £8,632
Expenses Reimbursed: £5,580 (Note: Exclds Insurances and Accounting Fees)
Dividends after tax: £64,313
Total Take Home: £78,525 (or 72.70% of contract value)

So if you are weighing up your decision purely on tax efficiency, a Limited Company will give you a far better tax home.

For all advice on setting up and managing your limited company, give us a buzz here at The Accounting Crew on 0203 859 6188.

For any advice on running your contract through an umbrella company, please call our sister company, CRUMB. on 0843 289 3993

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