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If you have made the move from being an employee to a freelancer, self-employed individual or small business owner then you have the choice of either working as a sole trader, limited company or employing the services of an umbrella company. If you decide to go limited it comes with greater accounting and bookkeeping responsibilities and is most suited to those who earn over £25,000 annually and will benefit the most from working tax efficiently.

If you feel that you are not yet at the stage of committing to limited company ownership then you have the choice of working as a sole trader or through an umbrella company. The best option will depend on your personal circumstances and priorities. Read on to find out what a sole trader and an umbrella company are, and the advantages and disadvantages of both options.

What is an umbrella company?

Umbrella companies act as employers to contractors, freelancers and self-employed workers. If you decide to work through an umbrella company you will essentially become an employee of that company. Those using this option are required to submit their time sheets to the umbrella company, who will then collect their earnings from the client and pay them on to you with tax, national insurance contributions and their fee deducted.

Advantages of using an umbrella company

If accounts and bookkeeping isn’t your forte then the major advantage of using an umbrella company is that they will relieve this burden from you. The umbrella company will deduct your tax and national insurance contributions so you know that your pay cheque is all yours and all you need to worry about is how to spend it.

Umbrella companies also provide a great temporary solution for those who are just testing the water and are not sure if they are ready to commit to being their own boss for the foreseeable future.

Another benefit of employing the services of an umbrella company is that they provide an easy way to make the transition from employee to self-employed, because someone else is handling the financials. This means that you are free to focus all your efforts on the running of your business until you are ready to take control of your company finances as well.

Disadvantages of using an umbrella company

In the same way that you would pay an accountant to take care of your accounts, leaving your bookkeeping in the hands of an umbrella company comes at a price and makes this option the most expensive way to operate.

As the umbrella company takes on the role of your employer, this option does not give you the freedom of being your own boss that you would experience if you were working as a sole trader or as a limited company director.

When using an umbrella company you are reliant on them to collect your earnings from your clients and pay them on to you. Not having control over your company accounts and finances could be a challenge for some self-employed individuals.

What is a sole trader?

A sole trader is a small business that is owned by one person. The owner takes all responsibility for the running of the business and is entitled to keep all net profits, but they are liable for any losses if the business was to hit hard times.

As a sole trader you are responsible for:

  • Any debts that your business may have.
  • The cost of expenses that are incurred for the running of your business, such as equipment, travel or stock.
  • Keeping records such as proof of income and expense receipts.
  • Completing an annual Self Assessment tax return.
  • Paying income tax and national insurance contributions.
  • Registering for VAT if your turnover reaches or exceeds the VAT threshold, which is currently £85,000 annually (April 2019).

Advantages of being a sole trader

Working as a sole trader gives you all the benefits of being your own boss without the extra administration responsibilities that come with limited company ownership.

Setting up as a sole trader is very simple as you can start trading straightaway, although you must remember to register as a sole trader with HMRC within three months or you may be liable for a penalty.

As a sole trader you are able to claim tax relief on business expenses, which are costs that are wholly and exclusively for the running of your business. To claim tax relief on these costs simply note the cost on your annual tax return and the total amount will be deducted from your taxable income.

For more information on expenses for sole traders you may find our self-employed expenses and top expenses to claim as a sole trader pages useful.

Another benefit of operating as a sole trader is that you can keep your business affairs private. Limited companies are required to make certain information including details of their company directors public, as a sole trader you do not have any such obligation, which gives you a greater element of security.

Disadvantages of being a sole trader

The main disadvantage of working as a sole trader is that there is no distinction made between your personal finances and your business finances. This means that your personal assets may be at risk if your business encounters any financial difficulties.

Another challenge that sole traders could face is that potential investors may see sole traders as less established and therefore less able to pay back money than limited companies, therefore raising cash to help your business grow could be problematic.

Sole trader businesses usually have just one employee. This means that taking holiday is more costly as the business will have to cease trading during the time that the owner is away.

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