Contractors are left with only a few options when it comes to deciding their means of payment structure, most commonly known as payroll. When being paid its vital that tax on any earnings is calculated and deducted as normal. This therefore requires becoming an employee of an umbrella company or starting up their very own limited company.

Both of these have their advantages and disadvantages, and will be dependant on each contractors specific requirements. But what are the advantages of both and the reasons for a contractor choosing one over the other?

An umbrella company, otherwise known as PAYE umbrella company, act as employers to any contractors that join them. In laymen’s terms this means that contractors remains earning at contractor rates, whilst being treated as an employee by the taxman. This will be at cost for the contractor with earnings smaller than those within a limited company but there is a balance. For example companies can provide contractors with support and will handle all of the administration and anything related to pay on the contractors behalf. Including time consuming VAT returns.

Another benefit is the ability to claim for an array of expenses that those operating under a limited company would be unable to claim. After each job is completed by the contractor, the umbrella company will invoice the client and deducts tax, whilst taking into accounts any expenses. Who then pays both tax and the contractor.

This form of payroll solution is often taken advantage of, by those wishing to contract short-term, or have other commitments that result in little time to dedicate to administration duties.

Limited companies, often known as personal service companies, are the most tax efficient form of payroll for those contracting in the United Kingdom.

The creator of the limited company will be in full control of all outgoings and incoming payments. The responsibility of financial elements and employment laws will be required. Therefore payroll calculations, invoices, taxation and insurance will all need to be managed. This can involve additional hours or the employment of an accountant. The hands on expectations will be high and working hours increased. But for those choosing contracting as a means of earning a living the rewards can be much higher. This is mainly down to higher percentage net pay and being outside the IR35 legislation.

For those deciding on their method of payment, it will be vital to take a number of precautions before deciding. This can range from many of the requirements mentioned above. Ranging from time available to each contractor and the length of contracts to willingness to work.

It's always recommended that anyone new to contracting seek professional guidance on whether a limited company or umbrella company. should be chosen.