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Should you be a freelancer or a limited company?

With the recent general election announcement, it’s no wonder why the press has moved on from covering Philip Hammond’s recent Spring Budget. At the time, coverage focused on the U-turned National Insurance Contributions (NICs) rise, but the most interesting part of the Budget, from a small business perspective, was what the chancellor said after he announced that increase.

Continuing his stated intention to treat taxpayers equally, Hammond pledged to tackle the “tax gap” between self-employed workers and director/shareholders of limited companies. Hammond said there are many “perfectly legal ways” an individual can lower their tax contributions if they trade as a limited company as opposed to a freelancer/sole trader, and that this discrepancy causes many to choose one over the other.

All of this talk raises the question: are there really more advantages to working as a small business director as opposed to a sole trader or freelancer? We take a look at some key areas to find out.

Limited company vs freelancer: taxes

Though the chancellor has made small changes to the system, which will come into effect next tax year provided he doesn’t U-turn on them as well, there are currently systematic differences in the taxation of self-employed freelancers and those who trade through a limited company.

Sole traders pay income tax on their earnings, currently at 20%-45% depending on their income. They also have to pay NICs. Class 2 NICs are charged at a flat rate of £2.80 a week. Class 4 NICs are 9% on profits over £8,060 and 2% on profits over £43,000. Philip Hammond planned to scrap Class 2 NICs while raising Class 4, and it seems that Class 2s will still be abolished now that Class 4s will not be raised.

Under the current system, a freelancer earning £20,000 would end up with £16,979.80 after tax.

As the owner of a limited company, profits will be subject to corporation tax, which is currently at 20%. Directors can give themselves a small salary and take any more money they require from the company’s profits in dividends.

Under the current system, a limited company director with a company that made £20,000 could end up with £18,245. They can do this by giving themselves a salary below the £11,500 taxable threshold, and taking the remaining money in dividends, which are tax free up to £5,000.

Both of these calculations have been made without taking into account business-related spending, which is tax deductible, and could end up changing your bill.

If you do choose to switch from limited company to freelance or from freelance to limited company, and you need help wrapping your head around the tax complexities, specialist accountants for freelancers or accountants for limited companies can help you out.

Limited company vs freelancer: the law

After taxes, the second biggest difference between limited companies and sole traders is with legal status. If you are a freelancer, you are your business. If you are a limited company owner, your business is a separate legal entity. This may not sound like an important difference to some, but it can have practical repercussions in many ways.

For example, if anything should go wrong with your work, you will be held personally responsible if you are a freelancer, but your company will be held responsible if you are a director. Thanks to this limited liability, shareholders and directors cannot be held responsible for the debt obligations of a company beyond their personal investment in the company.

In practical terms, this means that your company can go bankrupt without you going bankrupt too. If you are a freelancer and you go bankrupt, you are bankrupt yourself, and you are fully liable for any debts your company has — because you are your company.

It doesn’t have to be as scary as it sounds, though. There are several kinds of sole trader insurance that can help protect you from bankruptcy and any other financial pitfalls.

Limited company vs freelancer: employees

If your business grows and expands, you may find yourself needing to take on employees. Despite what the term suggests, “sole” traders can in fact hire people to work for them. Rather more obviously, so can limited company directors. But is it easier to do it one way or the other?

Employing someone for the first time is very similar whether you are a sole trader or a business director. First you have to register as an employerwith HMRC. Then you have to send your new employee a written statement of employment explaining the terms of what they will do.

After that, regardless of whether you are a freelancer or a limited company director, you will have to set up a payroll so you and your employees can pay PAYE taxes. You may also have to enrol your employees in a workplace pension scheme and provide other benefits. Whether you are a sole trader or you run a limited company, you will have exactly the same responsibilities once you become an employer.

This was posted in Bdaily's Members' News section by Caitlyn Stevens .