As a self-employed contractor, you have the option to set up your own limited company or work through an IR35 umbrella company. 

It’s a big decision as a self-contractor, and there are benefits and drawbacks to each option.

Let’s take a look at the real-life implications of choosing to work through an umbrella company, compared to setting up a limited company.

Specifically, we’ll be asking:

  • What is an umbrella company?
  • What does IR35 mean?
  • How do I find a good umbrella company?
  • What are the benefits of working through an umbrella company?
  • What are the drawbacks of working through an umbrella company?
  • How do I get paid under an umbrella company?

What is an umbrella company?

An umbrella company is a company that can employ a temporary worker, like a self-employed contractor, on behalf of an employment agency.

Once employed, the agency will then provide the services of the worker to their own clients.  

Umbrella companies hire on a contract basis that can be any length of time. While under contract, the umbrella company acts as the contractor’s employer and has to operate inside IR35 legislation.

What does IR35 mean?

IR35 is a piece of U.K. legislation made to recognise self-employed contractors and business owners who avoid paying higher income tax rates.

Previously, contractors and business owners could pay themselves a lower salary, avoiding higher income tax and national insurance contributions, then pay themselves dividends instead. 

This was seen as a form of tax avoidance by HMRC. So, they introduced IR35 to prevent this kind of behaviour by introducing harsher scrutiny for “off payroll-workers” who would previously have taken advantage of this tax loophole. 

Because of this legislation, registered umbrella companies must operate within IR35 regulations and apply the appropriate income tax, and national insurance contributions, to contractor’s salaries.

How do I find a good umbrella company?

There are loads of umbrella companies out there looking for contractors.

Because of IR35 however, the important part is finding one that will be compliant with the legislation. Working for an umbrella company that operates outside IR35 could get you into trouble with HMRC. 

To avoid getting into trouble, check umbrella companies for accreditations like:

  • FCSA (Freelancer and Contractor Services Accreditation) – the industry’s compliance gold standard. awarded to umbrella employers, limited company advisors, and self-employed/CIS contractor providers who demonstrate the highest industry standards
  • ASPCo (Association of Professional Staffing Companies) accreditation – an organisation dedicated to a strict code of conduct and professional compliance. They specialise in sectors that often need higher levels of protection, like umbrella companies.

The attention to IR35 has increased recently, so you can’t be too careful.

If you’re looking into an umbrella company and they describe your earnings as “tax free”, or “non-taxable”, this is a huge red flag and a sign they’re involving you in a tax avoidance scheme.

What are the benefits of using an umbrella company?

They essentially amount to the same benefits as having a regular employer.

  • You’ll be entitled to company benefits like payment into your pension scheme.
  • You’ll be protected by U.K. employment law.
  • You’ll be able to maintain the flexibility of regular self-employment, able to work both long-term, and short-term, contracts.
  • You won’t have to spend time seeking out and negotiating your own contracts.
  • You’ll still be able to claim some basic expenses back from HMRC.

Regarding IR35 rules, the main benefits of working through an umbrella company is the simplicity it offers when it comes to your taxes.

With an umbrella company, the company you work for acts as your employer. As such, they’ll take care of your income tax and national insurance contributions, taking it directly from your monthly earnings.

This is far easier than the procedure for limited companies, who must prepare annual statutory accounts that can be quite complicated.

What are the drawbacks of working for an umbrella company?

Working through an IR35 umbrella company can be a lot more convenient for contractors. However, with that convenience comes a few drawbacks, compared to setting up your own limited company:

  • You won’t be in control of your business operations.
  • You won’t be able to choose which clients you work for, or the rates you charge.
  • You won’t be able to claim as many expenses on your tax return.
  • You won’t benefit from private accounting knowledge.

Regarding IR35 rules, your income will be subject to regular income tax rates, which are generally higher than corporation tax rates and will increases depending on how much you earn:

Personal allowance

Any money earned under £12,571 will not be taxed.

Basic rate

Any money earned between £12,571 – £50,270 will be taxed at a rate of %20.

Higher rate

Any money earned between £50,270 – £150,000 will be taxed at a rate of %40.

Additional rate

Any money earned over £150,000 will be taxed at a rate of %45.

How do I get paid through an umbrella company?

As a contractor working for an umbrella company, you won’t be paid directly by the client. Rather, you’ll be paid by the umbrella company.

Because of this, the umbrella company will deduct a fee from your earnings to cover certain maintenance costs they pay for like:

  • administration costs (sometimes charged separately to you by the umbrella company)
  • employer National Insurance contributions
  • employer workplace pension contributions
  • holiday pay

The rate you get paid by an Umbrella company is called a “contract rate”, and is usually an hourly rate similar to the national minimum wage

Keep track of your finances with Countingup

Whether you’re setting up your own limited company, or working via an IR35 umbrella company, the Countingup app can help you easily manage all of your contracting income.

The Countingup business current account and accounting app is saving time for thousands of contractors across the UK by helping them automate the time-consuming aspects of bookkeeping and taxes.

The app gives you real-time insights into your profit and loss, tax estimates and the ability to create customised invoices in seconds. It means you can get an accurate picture of your finances working through an umbrella company and decide whether it’s the right choice for you.

Download the Countingup app to apply for your business current account in minutes. All you need is proof of ID and a selfie. Find out more here.