Being self-employed is a decision that isn’t taken lightly by most people.
The legal structure you choose to operate your business with should be taken just as seriously as the initial decision to go self-employed. This is because the legal structure impacts the potential risks, compliance issues, financial and tax implications that you will face as a self employed business owner.
Lets assume that as a first step into self-employment, you decide to trade your skills as a professional freelancer.
Freelancing and contracting tend to be used interchangeably however the main difference is with the number of clients you work with at any given time.
Whilst freelancers tend to work with several clients at a given time, contractors tend to be contracted to work with just one client over a fixed period of time. Whether you call yourself a freelancer or contractor is irrelevant to Her Majesty Revenue and Customs (HMRC), you still need to make sure that you pay the right tax on time.
HMRC are very keen on investigating “employees” disguised as limited companies in order to pay a lower corporation tax rate. This is called the IR35 status which every freelancer or contractor needs to be aware of. This can potentially create fines and huge tax charges accumulated as a result of being taxed at a lower limited company rate.
Freelancers enjoy flexibility, independence and freedom as a result of being their own boss. As a freelancer, you have the option of operating your freelance business as a sole trader, limited company, partnerships or limited liability partnerships or through a PAYE umbrella company.
What is a freelancer? Each will be described briefly but it is always worth speaking to an accountant to decide the best structure for you.
Sole trader
A sole trader is simply someone who runs a business without registering it separately as a different entity.
This is the simplest and least cumbersome way of starting and running a business. All you need to do is inform the Inland Revenue within 3 months of starting to trade that you are now a sole trader.
The downside of being a sole trader is that you are personally liable and responsible for any debts run up by your business. This effectively means that your personal assets may be recovered to pay off any debts that your business racks up! A sole trader pays income tax and national insurance contributions on their earnings.
Limited company
When you operate your freelance business through a limited company, you become a director who is responsible for managing the affairs of the business (which is considered to be separate from you).
Having a limited company offers some protection when things go wrong.
Your personal assets are protected in case the company has to be liquidated or dissolved which usually happens when the company is unable to meet its financial commitments.
You are personally protected from bankruptcy arising from business losses. This makes it easier to recover from any business failures and to try again. There are also tax advantages in the form of lower tax rates and deductible expenses for limited companies. Directors of limited companies pay both Income Tax and NICs on their director’s earnings.
Partnerships (ordinary or limited)
Partnerships are business where two or more persons, the partners set up a business and share the risks, costs and responsibilities of being in business.
Partners can be individuals, businesses or other partnerships. Ordinary partnerships are unincorporated businesses (the business has no separate identity from the partners). An ordinary partnership is the simplest form of partnership much like a sole trader.
With limited partnerships or limited liability partnerships the business is registered as a separate entity therefore the personal assets of the partners are protected when things go wrong, similar to a private limited company.
Each partner in any partnership needs to pay tax on their share of the profits and gains, and make National Insurance contributions on their earnings.
The main issues with incorporation (for both partnerships and limited companies) are the burden and cost of compliance. If you are however serious about running a freelance business then you shouldn’t be discouraged by the extra administration. In most cases, the benefits of incorporation far outweigh the disadvantages.
PAYE Umbrella companies
Freelancing through an umbrella company is a hustle free way of freelancing because you effectively outsource the invoicing and administrative aspect of being in business to the umbrella company who act as your employers.
The umbrella company acts as an agency and contracts you to various organisations.
The umbrella company pays you a salary through PAYE so you don’t need to worry about tax and NIC contributions but you potentially earn less than the other structures because you directly or indirectly pay for the service.
As a final word, starting any business venture is exciting but you must be certain there is a market and demand for your expertise.
Without demand, it can be stressful and an uphill struggle getting clients, which defeats the whole purpose of freelancing in the first place.
Griselda Kumordzie Togobo is a business consultant, speaker and coach dedicated to helping business owners increase their profits and productivity. She is a chartered accountant and holds an MPhil in Industrial Systems, Manufacture and Management from Wolfson College, Cambridge University.
I’m also an Enterprise Ambassador at Leeds University and guest lecture on entrepreneurship.
I founded AWOVI Consulting after a career with an international professional services firm where I provided business advisory services to small and medium sized Enterprises, Charities, The NHS and blue-chip companies.
I also own and run Forward Ladies where I am on a mission to make a difference in the lives of entrepreneurs as well as career women. Check it out.