Working as a contractor or freelancer

Employment options for contractors / freelancers

There are several main methods of trading that most people looking for a career in contracting turn to and these are:

Working via a PAYE umbrella company

Setting up your own limited company (PSC or Personal Service Company)

PAYE through an agency (if the agency offers this service)

Working as a sole trader

This guide discusses the advantages and disadvantages of each of the above contractor options.

Working as a contractor via an umbrella company

Not all umbrella companies are the same. Some umbrella companies simply act as a middleman between you and the client you work for. They offer you no employment protection and raise charges for processing your timesheets, invoices and expenses. Parasol, however, is a true employer providing you with a full contract of employment and all of the statutory protections that this entails e.g. holiday pay, sick pay, maternity pay etc.

With Parasol IR35 isn’t an issue because you’re our employee and pay PAYE tax and NIC on all your earnings. At Parasol we handle all the admin concerned with your contract such as invoicing, tax, VAT and National Insurance contributions.

When you’re on the umbrella company’s payroll, your pay is determined by your specific assignment, and the umbrella company will invoice, chase and retrieve the money due. Better still, they’ll help you claim all your legitimate employee expenses, which can be reimbursed to you PAYE tax and NIC free. Which in turn maximises the amount you take home.

A good umbrella company will also provide a full contract of employment, HR support, guaranteed hours of work, invoicing and timesheet management. And from 1st October 2011, ensure that everything is AWR compliant.

The best contractor focused umbrella companies will also issue invoices to the agency or client, collect payments, calculate PAYE tax and NI contributions and pay you direct to your personal bank account, without holding on to it. Better to have it earning interest in your bank account than in theirs!

An umbrella company is a great way of starting out, particularly if you’re not sure the contracting life is for you. You can dip your toe in the water without the commitment of setting up on your own. Having said that, we also work with thousands of contractors with years of experience who still prefer the umbrella option due to the lack of hassle involved.

So as a brief checklist, an umbrella company is a good choice if:

You’re a contractor working on short term assignments from 1 day to 6 months

You only plan to be a contractor for the short term

You want to test the water and try contracting for a while before committing

You have a natural aversion to paperwork and shudder at the thought of having to do a tax return

You want to stay out of the whole IR35 debate

You travel medium to long distances and claim travel and subsistence expenses

Not so good if:

Your assignments last longer than 6 months

You’re quite happy taking on responsibility for your accounts

You don’t have internet access

You can’t claim much by way of travel and subsistence expenses

You’re a higher earner, over £35,000 a year

Working as a contractor via your own limited company

Limited liability companies exist in their own right, which simply means for a contractor that their personal finances and their company’s finances are two separate things so a contractor will not be personally responsible for company debts (although as a company director you might be asked to give a personal guarantee for any bank loans etc).

Setting up a limited company is the most popular option for contractors, because it’s often the most profitable. For example, you may pay significantly less in National Insurance contributions.

However, it does come hand in hand with added responsibility; you’ll be running your own business, which means setting up a company, arranging your own insurance, finding an accountant, taking responsibility for your accounts, checking your IR35 status and making sure you’re paying the right tax.

That might sound like enough reason not to bother. But (and it’s a very big BUT), a specialist contractor accountant such as our sister company, ClearSky Accounting, will be able to help, taking the vast majority of responsibility off your shoulders and nearly all of the paperwork off your desk.

Contractors often test the water by going with an umbrella company first, then move on to setting up their limited company if they decide that contracting is their long-term career choice.

Contracting via your own limited company is a good choice if:

You’re a freelancer working on multiple short projects

You want to maximise the amount you take home

You’ve decided to commit to contracting for the long term

You’re happy to take on the extra responsibility

You have a specialist contractor accountant, like ClearSky on your side to take over the majority of paperwork and hassle

You’re happy to manage your own finances and set aside money to pay your tax

You want to be your own boss

Not so good if:

You don’t want any hassle or responsibility at all

You can’t get your head around the basic principles of tax, IR35, National Insurance contributions and so on

You want to pay tax as you earn (PAYE), instead of being landed with one big tax bill

You earn below £35,000 a year

You’ve been bankrupt in the past

Agency PAYE

Agency PAYE is sometimes offered by recruitment companies.

Whilst they pay you and sort out your tax and National Insurance contributions on a Pay As You Earn (PAYE) basis, like an umbrella company, there are significant differences. You’re not employed by the agency, so you will not have employment rights such as Statutory Sick Pay (SSP) and you can’t claim expenses. You can offload some of your paperwork, so it’s less hassle in that respect, but you may end up having to change agency with each new assignment. The service isn’t always offered by recruitment agencies and, where it is, it’s usually geared more towards temporary positions, such as secretarial or bar work.

Good choice if:

You’re looking for occasional temp work, such as secretarial or bar work

You don’t think you will be facing additional expenses in order to complete the assignement

You want someone else to sort out your tax and National Insurance without having to think about it

Not so good if:

You don’t want to be tied to one agency

You change assignments frequently

You want to maximise your income and claim expenses

You earn over £35,000

You want employment rights

Contracting as a sole trader

Working as a sole trader is a simple form of contracting, however, you could argue that it’s also the riskiest. It’s the simplest because all you have to do is register as self-employed with HMRC. It’s the riskiest though because you are personally liable for any debts that your business runs up, this means your home or other assets could be at risk if things go wrong.

Working as a sole trader means you will need to complete a self assessment tax return every year but, as with running a limited company, a good accountant specialising in accounting for contractors will be able to handle all the nitty gritty for you.

There are two main issues that put contractors off however; firstly, you may have to find all your assignments yourself, rather than going through an agency, because of the employment risk involved for an agency. Secondly, being self employed doesn’t always enable you to maximise the amount you take home, as you’ll have to pay tax on all of your income, as opposed to a limited company, where you can possibly reduce the amount of tax and NIC that you have to pay.

Good choice if:

You work for a number of different clients simultaneously

You want to reduce your legal responsibilities

You want to be your own boss

You want to set up quickly, easily and cheaply

Not so good if:

You want to maximise your tax efficiency and the amount you take home

You don’t want the responsibility of finding all your assignments by yourself

You have longer assignments that last a minimum of a few days