Generally speaking, most contractors choose to organize their activities under either a limited liability company or an umbrella company.
(In the latter case, a professional management firm takes responsibility for basic administrative operations.)
Here’s a brief rundown on the advantages and drawbacks of contracting through an umbrella company.
- Setting up an umbrella company is fast and relatively hassle-free. It’s perfect for situations where time is at a premium.
- Umbrella companies are ideally suited for use in a short-term contract situation. Setting up a limited company may involve too much administrative investment to be worthwhile for a short period of time.
- The usual tax benefits provided by limited companies are much reduced if your contracts are subject to IR35 restrictions. Using an umbrella company is a workable solution.
- We can handle all aspects of umbrella company administration (including tax calculations) without obliging you to, for example, hire an accountant.
- You avoid the legal and financial obligations imposed on you by forming a limited company.
- Your own administrative obligations (time reporting, expense recording, etc.) are minimized, reducing the amount of time you waste on paperwork.
- Umbrellas are ideal for launching a contracting career. You’ll be able to get straight to work without involving yourself in any long-term complications by forming a limited company of your own.
Using an umbrella company is not the most efficient choice from a tax standpoint. You will end up paying income tax and NICs on all of your income.
Directing a limited company (provided you are not caught by IR35) is different. Salary payments avoid income tax and NICs, and dividends avoid at least the latter complication.
Unlike forming a limited company of your own, an umbrella company removes you from basic company operations. While this is typically a benefit, there are some circumstances where it can be a hindrance.
Entrusting your business to an umbrella company makes you reliant on its services to invoice for your work and receive payment from your clients. There are also a number of other cons according to Charles Hunter.
If you choose to go the limited route, you can adjust your income and draw dividends whenever you like. In contrast, the umbrella scheme obliges you to work with the company’s schedule when it comes to payments.
This is not something which can be altered on short notice.
Have you ever considered contracting through an umbrella company? Share your story about how it went for you in the comments below.