The most professional way to start IT freelancing? It’s as a limited company

Now you’re up to speed with operating as a sole trader to start your freelance technology career, it’s time to explore another option worthy of serious consideration -- especially if tax-efficiency and professionalism matter to you -- and that’s to form a limited company.

Misperception, intention, and a nice-to-have

Many people have the mistaken belief that they should set up a limited company only if they want to grow and eventually employ people, writes Harry Gruffydd, limited company operations manager at Workwell.

On the contrary, a limited company can be a good working option, even if you intend to work solo for the long-term, and regard growth only as a nice-to-have.

What’s the best IT freelancing structure (for you)?

The right approach to how you structure your technology career as a freelancer will largely depend on your personal circumstances and how much administration you’re happy to take on.

Running a limited company need not be daunting, but there are a number of administrative tasks you need to be committed to if you are to operate compliantly in the eyes of HMRC.

For this reason, most people enlist the support of specialist contractor accountant (like us!) to make sure they do everything right as an incorporated business. 

Limited company and PSC, they are one and the same…

Before we look at the advantages and disadvantages of IT freelancing through a limited company, it’s important to be clear about terminology.

For one-person companies, the terms ‘limited company’ and ‘Personal Service Company’ (PSC) are interchangeable. They are, in effect, the same thing. A PSC is a limited company with only one person who is usually the shareholder, director and employee. It’s just another example of the many hats you have to wear when working for yourself!

Three big advantages of using a limited company for IT freelancing/contracting

1. Reputation

Operating via a limited company can send a message to your clients that you’re more serious about building a successful, stable freelance career for the long-term.

Limited company status sends a message of confidence to your clients, especially in professional sectors like IT, and elevates your status from freelancer to business-owner. So forming a limited company may help you attract more lucrative work.

2.     Tax-efficiency

In many instances, despite recent changes to tax rules, being a limited company contractor is a more tax-efficient way to work. This is because you can pay yourself through a mixture of salary and dividends.

Most limited company owners take their personal allowance (£12,570) as a salary and then dividends within the basic rate allowance (£12,571 - £50,270). The basic rate dividend tax is lower (8.75% compared to the basic rate income tax of 20%), because you’ve already paid corporation tax on your profits.

You also get a £1,000 dividend allowance each year. If you wish, you can pay up to £60,000 a year into a personal pension without paying tax on the earnings, and this is deducted from your profit before the corporation tax calculation, further reducing your tax liability.

It may sound complicated -- at first! But with the help of a specialist contractor accountant, you can get tailored support and the whole process will become clearer.

3.     Limited liability

When operating through a limited company your personal assets are generally protected from business debts and legal liabilities. This is in stark contrast to sole traders who are personally liable for all business obligations.

The disadvantages of using a limited company for tech contracting

A limited company comes with administrative requirements and costs which sole traders don’t have to worry about.

Forming your company

If you operate as a sole trader, you simply register as self-employed with HMRC and go to work. A limited company, on the other hand, has to be created through a business formation process which involves registration with Companies House and HMRC.

You’ll also need to set up a business bank account, so your business and personal finances are separate. Many limited company IT contractors tend to appoint an accountant to manage their business formation so that everything is done compliantly.

Running your company: the realities

Once set up, you’ll have an obligation as the company’s director to maintain accurate financial records and submit annual financial statements to Companies House and HMRC. This means you must keep on top of your paperwork and finances which takes effort and discipline.

You also need the appropriate time for these tasks in your schedule, and although an accountant can take some of the admin off of your shoulders, you (the taxpayer), ultimately remain responsible for your tax affairs.

So key tasks of running a limited company, like submitting annual accounts and tax returns, are yours, even though a tax adviser can of course assist and facilitate. With or without an accountant, managing your business’s finances on an everyday basis is an ongoing commitment.

Final thought

Whether to operate as a sole trader or limited company as a technology contractor depends on your individual circumstances and goals. Limited company status certainly offers a number of big advantages but also comes with additional administrative requirements and associated costs. It’s always helpful to get good advice before deciding the right route for you.