If you’ve recently decided to make the leap into the freelance world then your first question was probably ‘should I set up a limited company or just register as self employed?’ Both are valid means of declaring your earned income to HMRC but this article has been designed to dive deeper into the differences and advantages of each.

Registering as self-employed:

This is the easiest and cheapest way of declaring your earned income as you don’t need to hire an accountant and can process all the paperwork yourself. To get started you just need to register with HMRC for Self Assessment. (Do this as soon as possible after starting work or you could be liable for a penalty fee). Once you are registered and have your Unique Tax Reference (UTR) number, you just need to keep track of all your invoices and expenses and file your tax return online at the end of the year. Some people keep track of all their incomings and outgoings through excel spreadsheets but there are now some quite nice online accounting solutions that are definitely worth a look. (QuickBooks for example).

Being self-employed is also generally considered to be more tax efficient for those earning less than £40,000 a year. It is also possible to register for VAT and claim this back on your purchases. VAT registration is optional to begin with but once your turnover reaches £82,000 in a taxable year, this becomes compulsory.

So what’s the catch? Well, being registered as self-employed can cause issues with getting employment. Larger companies tend to prefer working with limited companies and some wont work with self-employed individuals at all. The same goes for agencies tasked with finding work on your behalf, many now require that you register as a limited company and ditch the self-employed (sole trader) status.

Much of this is due to a piece of government legislation called IR35. This legislation is in force to stop companies using self-employed individuals who should be hired full time. Here’s an example:

John Smith is a self-employed freelance editor who has been hired by a company to edit some internal communications videos. John is asked by the company to work FULLTIME Monday to Friday, 9am to 5pm every week until further notice.

Now, every company has a legal obligation (to its employees) to pay their tax, national insurance and pension contributions each month. They are also required to give paid holiday and sickness cover. As John Smith is not technically an employee (as he’s self-employed) he will not be given these benefits and most importantly, has no rights when it comes to redundancies. This means John could work at this company for a year and then be told one day to not come in anymore without notice or additional pay.

IR35 is a piece of legislation that prohibits companies acting in this way, as they should indeed be offering John a full time PAYE contract instead. Self-employment is intended for people who work multiple jobs for multiple clients on an ad-hoc basis.

Now being self-employed doesn’t mean you wont be able to get work as a freelancer, it just means you may struggle with some clients. Being self-employed also gives you no protection when it comes to liability – something we’ll talk more about around limited companies.

So in summary:

PROs of being self-employed

• Easiest & cheapest way of declaring your income
• Doesn’t require an accountant
• More tax efficient when earning under £40k
• You can still register for VAT
• You can manage everything yourself

CONs of being self-employed

• Some clients / agencies may only want to work with limited companies
• Your financial liability is not limited. The buck stops with you

Setting up a limited company:

This is a more complicated and expensive way of declaring your earnings but does have its advantages. For starters you appear more professional to clients if you’re a limited company and become less of a concern around IR35. There are also distinct tax advantages if you’re earning over £40,000 a year and most importantly you have what is called ‘limited liability’. What this means is the financial liability you have stops with the company so if the company were to be sued, the plaintiffs are suing the company, not its owners or investors.

Setting up a limited company is actually quite straightforward and can be done through Companies House. You will need to hire an accountant though as filing the end of year accountants is not something you can do yourself without the relevant training. You also need to be sure to file your annual return each year but most accountants will take care of this as part of their annual fee. To give you an idea, a newly incorporated company with just the one employee (yourself) is likely to cost around £1000 a year for professional services. This does assume however that you will still keep track of your invoices and expenses through a spreadsheet or online accountancy software. Indeed, some accounts are prepared to all this for you but be prepared to pay extra for the service.

Registering for VAT is also straightforward and allows you to claim VAT back on your expenses. VAT registration is optional to begin with but once your turnover reaches £82,000 in a taxable year, this becomes compulsory. There are also various different VAT schemes that may be of interest so please speak to your accountant for advice.

So in summary:

PROs of setting up a limited company

• Limited financial liability
• Most clients prefer working with limited companies
• More tax efficient when earning over £40k
• You can still register for VAT
• You appear more professional

CONs of setting up a limited company

• Costs around £1000 a year for an accountant

In our opinion, if you can stretch to the fee for the professional services then set yourself up as a limited company. It’s likely to open more doors in the future and gives you a slight edge over other freelancers who are just self-employed.