Umbrella company: Do you need one?

What is an umbrella company?

An umbrella company is an entity that acts as an employer for contractors who work on short-term contracts or freelance projects. Essentially, when you work under an umbrella company:

• They become your legal employer: Even though you work for different clients, the umbrella company is technically your employer on paper.
• They handle the paperwork:
  • Invoicing your clients on your behalf.
  • Deducting your taxes (PAYG) and superannuation contributions.
  • Ensuring you get paid on time, regardless of your clients' payment schedules.
  • Managing compliance with Australian Tax Office (ATO) regulations.

This arrangement is especially beneficial for:

• Contractors working through agencies: Agencies prefer dealing with one umbrella company rather than numerous individual contractors.
• Contractors with multiple clients: Simplifies tax and admin, saving you time and potential headaches.
• Contractors new to freelancing: Provides a smoother transition to self-employment without the initial administrative burden.
• Overseas contractors: Umbrella companies can assist with work visas and navigating Australian tax laws.

However, there are trade-offs:

• Fees: Umbrella companies charge for their services, which can reduce your take-home pay.
• Reduced flexibility: You're technically an employee, so there might be less control over certain aspects of your work.

The idea behind umbrella companies is to reduce the hassle of being self-employed by providing a middle ground between full employment and running your own business. While the concept may sound attractive, the costs can quickly add up, and the flexibility contractors value can be seriously diminished.

How do you get paid as an umbrella company?

When you work under an umbrella company, your earnings go through them first. You typically submit timesheets or invoices to your clients or recruitment agency. The umbrella company then invoices your client on your behalf and collects the payment. Once they receive the money, they deduct necessary taxes such as PAYG (Pay-as-you-go) tax, Superannuation contributions, and fees. After these deductions, they pay you the remainder as a salary.

Since the umbrella company technically employs you, your income is subject to PAYG taxation, which means your earnings are taxed progressively, just like an employee's salary. While this regular payment method might be helpful for those who prefer the stability of a 'salary', it doesn't make sense if you want to run your own business. Firstly, you get paid minus your tax. One of the most significant advantages of running a business is managing your cash flow throughout the financial year. Using an umbrella company can also restrict your flexibility in managing your finances, especially if you want to optimise your earnings through tax deductions and business expenses.

What are umbrella company fees?

Umbrella companies charge fees for their services, typically as a flat weekly or monthly rate or as a percentage of your income. In Australia, umbrella company fees can vary significantly. On average, fees range from $100 to $200 per week for essential services, but they can go higher if you require additional services like tax advisory or financial planning.

For example, if you earn $100,000 a year, and your umbrella company charges a fee of $100 per week, this equates to over $5,200 annually. While this might not seem excessive initially, it can represent a substantial portion of your earnings over time. When you factor in other overheads, such as insurance or agency fees, the cost of using an umbrella company can severely impact your take-home pay.

In addition, some umbrella companies charge hidden fees for same-day payments or end-of-year tax summaries. Before signing up, it's crucial to carefully examine the complete list of fees to avoid surprises later on.

Are umbrella company fees tax deductible?

In most cases, umbrella company fees are not tax deductible in Australia. This is because these fees are for services the umbrella company provides, including managing your taxes, superannuation, and payroll. Essentially, you're paying for the convenience of having someone handle your administrative work, but the fees are considered personal costs and not deductible business expenses.

It's essential to consult an accountant to understand the tax implications of using an umbrella company. While the umbrella company helps manage your taxes, you may still need to file your tax return, and understanding what deductions you're eligible for can help maximise your savings.

Here's a breakdown of why umbrella company fees are generally not tax-deductible:

• Personal vs. business expenses: The ATO distinguishes between personal expenses (costs incurred for personal benefit) and business expenses (costs directly related to earning your income). Umbrella company fees, while indirectly supporting your business, are primarily for personal convenience and don't directly contribute to generating income.
• Nature of the services: The services provided by an umbrella company, such as payroll and tax management, are considered administrative or compliance-related. These services don't directly enhance your skills or contribute to the core activities of your business, making them less likely to qualify as tax deductions.
• Lack of direct link to income generation: To be tax-deductible, an expense must have a clear and direct link to generating your assessable income. While an umbrella company's services indirectly support your ability to work, they don't directly result in earning more income or securing new contracts.

However, there might be exceptions depending on your specific circumstances and the nature of the services provided by the umbrella company. It is crucial to consult with a qualified tax professional or accountant to assess your eligibility for any deductions related to umbrella company fees.

Umbrella company vs PAYG

Many contractors and consultants in Australia weigh the choice between working through an umbrella company and handling their taxation. When you work through an umbrella company, they operate a PAYG system on your behalf. The difference is that you are outsourcing the administration and paying for it through their fees.

On the other hand, if you choose to operate your business yourself, you can still get the benefits of contracting with the peace of mind that your taxes are sorted. Thriday automates your tax, accounting, and invoicing processes. This allows you to retain more control over your finances and keep more of your income by avoiding umbrella company fees.

With Thriday's automated accounting, you only pay taxes based on what you owe, without any middlemen taking a percentage of your earnings. You also retain the freedom to manage your deductions and optimise your tax strategy, something that's impossible to do under an umbrella company setup.

In short, if you use an umbrella company, you pay your taxes with every pay cheque, and you cannot invest your savings or earn interest on that money. With Thriday, you pay your taxes at the end of the year, and you use that money to grow your business and earn interest with Thriday's interest-earning feature.

What are the advantages of using an umbrella company?

For many, the primary benefit of using an umbrella company is simplicity. It eliminates worrying about tax calculations, bookkeeping, or invoicing. Instead, the umbrella company handles all of that on your behalf. This can be a good time saver, especially if you're working multiple contracts or don't have a background in accounting.

The umbrella company also provides a regular, stable income. Since your taxes and superannuation contributions are automatically deducted, there are no unexpected bills at the end of the financial year.

What are the disadvantages of using an umbrella company?

The biggest drawback to using an umbrella company is the lack of control and cost - you might as well be a regular employee. As mentioned, the fees can be substantial, especially for long-term contractors or consultants. Over the course of a year, these fees can add up to thousands of dollars, reducing your overall earnings.

Another disadvantage is the lack of flexibility. When you work through an umbrella company, you lose some control over how your finances are managed. This includes the ability to claim deductions on business expenses or optimise your tax position. For many contractors, this lack of financial flexibility means they cannot maximise their take-home pay as they could if they managed their accounting.

Additionally, working through an umbrella company means your status is more akin to an employee than a business owner. This can restrict your options for growth, particularly if you're looking to expand your operations or take on more complex contracts.

How do I pick the right umbrella company?

If you decide that an umbrella company is right for you, choosing one that fits your needs is essential. Here are some factors to consider:

1. Fees: Make sure the fees are clear and transparent. Ask about hidden costs, such as fees for same-day payments or end-of-year tax summaries.
2. Service offerings: Do they offer the services you need, like tax advisory, financial planning, or insurance coverage? Some umbrella companies offer essential services, while others provide a more comprehensive package.
3. Reputation: Look for reviews and feedback from other contractors. What is their track record with payments and customer service? Are they compliant with ATO regulations?
4. Transparency: Make sure they provide clear and easy-to-understand documentation. This will help you avoid any issues with tax reporting or compliance later on.

Why is Thriday better than using an umbrella company?

Thriday offers a smarter, more cost-effective alternative to umbrella companies. Instead of paying high fees for essential services like tax processing and invoicing, Thriday provides automated accounting and bookkeeping that simplifies running your business.

With Thriday, you can control your finances without needing an intermediary. All tax calculations, invoicing, and bookkeeping are automated, meaning you can track everything in real time and avoid the high fees associated with umbrella companies. Plus, Thriday provides fractional accounting and tax agents, so you can connect with a person when you need them. It integrates directly with the ATO, making tax reporting seamless and ensuring compliance without the guesswork.

By using Thriday, you can earn interest on your savings, avoid unnecessary fees and retain flexibility. With Thriday, you can manage your business expenses, claim tax deductions, and grow your business on your terms. Thriday provides the convenience of automation without the high costs of using an umbrella company.

What features does Thriday offer?

Thriday combines banking, accounting, and tax services into one easy-to-use platform. Some key features include:

• Automated tax calculations: Thriday calculates your tax, GST, and other obligations in real time, so you always know where you stand.
• Integrated bookkeeping: Expenses, invoices, and payments are tracked automatically, which means less time spent on paperwork and more time focused on growing your business.
• ATO integration: Thriday integrates directly with the ATO, ensuring compliance and reducing the risk of fines or errors in your tax reporting.
• Expense tracking and reporting: Thriday allows you to automatically track your expenses and generate financial reports. This helps you stay on top of your finances and efficiently prepare for tax time.

With Thriday, you get all the benefits of an umbrella company—such as automated tax handling—without the high fees or loss of control. It's a cost-effective solution for anyone looking to manage their business finances more efficiently.

Final thoughts

Umbrella companies can be useful for contractors and consultants who want convenience, but they come at a cost. While they take care of your taxes and payroll, the fees can eat into your earnings, and you may lose some flexibility in managing your finances. Thriday offers the same benefits—automated tax handling, expense tracking, and bookkeeping—without the high fees or loss of control for those looking for a more innovative, more affordable solution. If you want to take control of your business finances without the hassle of an umbrella company, Thriday is the better choice.

Frequently asked questions

How does an umbrella company impact my ability to claim work-related expenses?

While working through an umbrella company, you might have limited ability to claim certain work-related expenses compared to being a sole trader. This is because the umbrella company typically covers some standard expenses as part of their service fee. Consult with a tax professional to understand which deductions you might still be eligible for.

Can I use an umbrella company if I'm already registered as a sole trader or have my own company?

Generally, umbrella companies are designed for contractors who don't have their own business structure. If you're already a sole trader or have a company, using an umbrella company might not be the most suitable option, as it could add unnecessary complexity and costs to your existing setup.

How does an umbrella company affect my superannuation contributions?

Umbrella companies are responsible for making the mandatory superannuation guarantee contributions on your behalf, ensuring you meet the legal requirements. They will typically deduct these contributions from your earnings before paying you your net salary.

Can I work for multiple agencies or clients simultaneously through an umbrella company?

Yes, one of the key benefits of using an umbrella company is the ability to work for multiple agencies or clients at the same time. The umbrella company handles the invoicing and payment processing for all your engagements, simplifying your administrative workload.

Are there any industries or professions where using an umbrella company is more common?

Umbrella companies are popular in various industries, particularly those with a high prevalence of contract or freelance work, such as IT, consulting, creative services, and engineering. They are also commonly used by professionals who frequently change clients or projects.

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