What is the best business structure for freelancers?

What is the best business structure for freelancers?

You’ve finally plucked up the courage to embark on that freelance venture that’s been burning a hole in the back of your brain for years – but deciding to take the plunge only brings more questions.

From what bank account to open and how to create a business plan to which insurance policies you should take on, new freelancers have plenty of issues to resolve.

But perhaps the biggest question is what the best business structure to adopt. The most common options are sole trader and limited company but there are others, notably a Limited Liability Partnership (LLP).

Before making what might be one of your most important business decisions, it is worth looking at the advantages and disadvantages of each option.

Each structure has different implications for tax, and it is also worth remembering that as your business grows and changes then the correct structure may also vary.

Sole trader – your company, your profits, your risk:

A sole trader owns their business outright and will be responsible for all decisions. Ultimately, a sole trader and their company are legally considered as one entity.

This is the most straightforward structure, under which a freelancer would keep all their profits after income tax. However, they would also be personally responsible for any losses.

As far as tax rules are concerned, sole traders must pay:

• Income tax on all profits
• Class 2 and Class 4 National Insurance
• VAT if they earn more than £85,000 per year

Being a sole trader comes with several advantages:

• It is quick and easy to set up
• There is less admin than with a limited company
• You keep all your profits after income tax
• You can start trading immediately, subject to getting any necessary insurances or licences
• It is still possible to employ staff
• You have complete control of your business
• Accounting can be more straightforward. Once a year, you need to add up all your income and expenses, and HMRC then calculates your tax
• You have more privacy as your business information and accounts are private
  
  

The sole trader structure does have some clear disadvantages though:

• You will be personally responsible for your company’s debts and could even be made bankrupt and your personal assets – including your home – sold
• You are also responsible for any legal issues your company has
• You may be missing out on tax advantages; for example, you can’t defer profits in future years or claim dividends
• It is harder to pass the business on through inheritance or sale
• You need to keep thorough records of income and expenses – HMRC has a list of everything you need

Freelancers who set up as a sole trader are required to notify HMRC within three months of the date they start trading.

Limited company – Legal safety but increased admin:

A limited company is legally separate from the person or people who set it up. This means it is responsible for its own debts and if the company goes bankrupt, the individual won’t suffer as long as they can demonstrate they have run it legally and in good faith.

Operating as a limited company can also lend freelancers an air of credibility, but working within the confines of a legally separate entity does come with increased administrative and regulatory burdens.

Limited companies also have to submit annual accounts to Companies House and directors must pay income tax, dividend tax and national insurance while the company itself is liable for corporation tax, VAT if it earns more than £85,000 a year, and National Insurance.

Advantages of operating as limited company include:

• Being able to separate personal and business finances, and not being personally at risk if the business goes bankrupt
• Increased credibility with other businesses
• The name you register with at Companies House is yours and yours alone, and it is protected by law
• The ability to keep profit within the business, which can reduce your tax bill as corporation tax is generally lower than income tax
• It can be easier to sell an incorporated business from a legal and tax perspective

There are disadvantages as well though:

• The company must be registered at Companies House and pay annual fees
• This structure comes with increased regulation and administration
• It is generally more complicated and costly to produce accounts, and they will require auditing even if your profits are low
• Your business accounts will be public
• You will have to make National Insurance payments as both an employer and an employee if you draw a salary of more than £153 per week

There are a lot of things to remember if you decide to form a limited company, from choosing a company secretary to identifying who has significant control and keeping a raft of records.

Partnerships – it takes two:

Freelancers also have the option of pursuing partnership options. There are two routes that can be explored in this instance.

The first is a basic partnership, which works on much the same basis as becoming a sole trader. This is a simple structure, with the only difference being there is more than one owner involved.

Each owner is jointly responsible for the businesses’ debts, bills or tax, and they will also share any profits. A partner can be both a real person and a limited company, which legally counts as a person.

The second partnership option is a Limited Liability Partnership or LLP, which is the equivalent of a limited company but operating on a partnership basis.

As such, an LLP provides more protection against personal bankruptcy. It is more complex and must be registered with Companies House – just like a limited company.

Details such as how profits are shared, the way in which decisions are made, each member’s responsibilities, and how people can join or leave the LLP have to be laid out, and there are further rules around the naming of the partnership and the requirement for a registered address.

In both of these partnership options, the main advantage comes from being able to share both responsibility and risk, as well as drawing on the skillsets of each partner involved, but there are disadvantages as well.

Freelancers who decide to pursue partnership routes will lose some control over their business and its structure, and they could miss out on valuable tax advantages that would be available by incorporating.