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What business structure is best for a contractor? What business structure is best for a contractor?

What business structure is best for a contractor?

06 Aug 2021

Different firms hire independent consultants, contractors and freelancers on a short-term basis. These short-term contracts allow the firm to have specialist skills, experience, and knowledge without full-time employment. This is quite appealing due to the several benefits the opportunity offers.  

If you want to be a contractor, you need to consider several things first, such as the legal setup or legal structure to adopt for your business and which accounting services for contractors you need.

Your legal structure affects different aspects of your business, including your management structure, records and how much tax you will pay. Like other startup businesses, you would have the following options;

  • Opt for a limited company
  • Operate as a sole trader
  • Create a partnership

Operating as a sole trader

A sole trader business setup is the simplest way to operate as a contractor in tax and administration. You won't have to register with Companies House. This means you won't have to file annual accounts, and you have little admin work to do before getting started.

When you opt to operate your contractor business as a sole trader, you and your business are legally the same. This means there is no distinction between the business and yourself, so you can keep all profits after paying tax.  

However, the business's liabilities and debts are your responsibilities. If the business gets into trouble, the legal and financial responsibilities are yours.  

  • Paying tax as a sole trader contractor

Running your contractor business as a sole trader requires you to register for a self-assessment with the HMRC and complete a tax form every year. Keeping accurate records of your business expenditure and income will help you pay the right amount of tax, and you can also claim some expenses.

You may also need to pay fixed-rate Class 2 National Insurance Contributions (NICs) and Class 4 National Insurance Contributions on profits you make when running your contractor business as a sole trader.

  • What are the benefits of a sole trader contractor?

Many contractors prefer to run their business as a sole trader because starting up as a sole trader is easy and more flexible. All it involves is recording your losses and profits (bookkeeping), paying bills and submitting your Self-Assessment tax return on time.

  • What are the disadvantages of a sole trader contractor?

As a sole trader, you are responsible for running the business. This means that the liabilities and debts from the business are yours, and you would have to pay out-of-pocket. Your assets would also be at risk if cash is unavailable in the business and you have bills to pay.

Some contracting agencies prefer not to work with sole traders, so operating your business as a sole trader may be a disadvantage.

Running a limited company

Limited companies are entirely separate entities from the business owner and directors. Suppose you run the contractor business as a limited company. In that case, you are not legally responsible for the company's liabilities and debts, but this means the profits belong to the company, not you.

To run the business, you have to register as a limited company with Companies House. This process is called incorporation. You would also need at least one director to startup the business and submit the business's annual accounts to Companies House.

  • Benefits of running a contracting business as a limited company

Although setting up a limited company costs more and requires heavy administrative work, the business will pay for itself if anything goes wrong, and only business assets can be seized.

Running a limited company is also more tax-efficient. In most cases, the owner of the company is both a director and a shareholder. This means the owner can take salaries as an employee and get dividends from the company.

A benefit of a limited company peculiar to contractors is that starting a limited company helps the business look more credible. Since many contracting agencies do not like working with sole traders, you have more opportunities to get contracts and easily raise finance.

  • What does running a limited company involve?

As the company's director, your responsibility is to ensure the company submits the correct accounts and tax returns to HMRC and Companies House every year. As the company director, you would also have to complete a Self Assessment tax return.

If you do not fill in tax returns, you have to sign up for the Self Assessment on the Gov.uk website. Alongside submitting your tax return as a director, you need to provide details of the income received as a director and any other income.  

Setting up a partnership

In setting up a partnership as a contractor, you can share the business's risks, responsibilities and costs. A partnership allows two or more contractors to own and run a business. It doesn't require registering the business with Companies House, which reduces the administrative work.

Each partner is self-employed and registers the partnership for Self Assessment. A partnership doesn't have a legal status like a limited company. The business only serves as a link between two or more self-employed people. However, partners can also run a limited company.

People involved in a partnership get to share the profits from the business, except they have a different agreement.  

  • What are the disadvantages of setting up a partnership?

If you are in partnership with someone, you have to trust the person completely. However, you still need to set up an agreement before starting the business because all liabilities and debts from the business are each partner's responsibility.  

People owed by the business can seize the assets of each partner. Even if your business partner is responsible for the debts, you are still liable.

Most partnerships do not file public accounts with Companies House, so some contracting agencies are cautious about working with contractors in a partnership.

Running a limited liability partnership

A limited liability partnership (LLP) offers partners the benefits of limited liability and allows them the flexibility of organising the business like a regular partnership.

LLPs are legally separate from the owners, so the business is responsible for its debts, liabilities and assets. The liability of each partner is limited to the amount invested in the business.

Regardless of which business set up you choose as a contractor, you need an accountant and solicitor before starting the business, so you don't run into problems while starting your business.

Sorting out the tax and legal implications of being a contractor can be challenging, so visit theaccountants.london today to discuss your business options with a professional.