PAYE vs umbrella is a choice faced by thousands of contractors in the UK.

The option you choose will impact many aspects of a contractor’s day-to-day life, therefore, it isn’t a decision that should be taken lightly. Every contractor should do their research and look into the pros and cons of each route, to find the best option for you.

To help, in this guide Umbrella Broker has put together this handy guide outlining the key differences between PAYE vs umbrella, so every contractor can make the right choice for them in 2021.

PAYE (pay-as-you-earn)

The first option is PAYE.

PAYE stands for pay-as-you-earn which is the most common form of income tax in the UK and is how most payroll workers pay their tax.

With the PAYE system, tax and National insurance contributions are taken from a worker’s salary before it is paid to them, based on how much they are earning.

Most workers in the UK are taxed under the PAYE system, apart from those that work off-payroll. These off-payroll workers or businesses will instead fill out a self-assessment tax return which is done annually, quarterly or monthly after their income and outgoings have been processed.

Payroll workers that are taxed through PAYE are subject to current 2021-2022 tax bands as follows:

England

• Tax-free Personal allowance: up to £12,500 per year
• Basic rate (20%): £12,501 – £37,500 per year
• Higher rate (40%): £37,501 – £150,000 per year
• Additional rate (45%): over £150,000 per year

Scotland

• Tax-free Personal allowance: up to £12,500 per year
• Starter rate (19%): £12,501 – £14,585 per year
• Basic rate (20%): £14,586 – 25,158 per year
• Intermediate rate (21%): £43,431 – £150,000 per year
• Top rate (46%): over £150,000 per year

Wales

• Tax-free Personal allowance: up to £12,500 per year
• Basic rate (20%): £12,501 – £50,000 per year
• Higher rate (40%): £50,001 – £150,000 per year
• Additional rate (45%): over £150,000 per year

If a contractor chooses to work through a PAYE agency, the agency will employ the contractor meaning their tax and National Insurance will be processed under the PAYE system in line with current tax bands.

Umbrella company

The second option for contractors is to work through an umbrella company.

Just like with a PAYE agency, an umbrella company will also employ the contractor, paying them a salary and processing their tax through the PAYE system.

Although both the PAYE and umbrella company routes both process tax in the same way, there are several key differences between the two.

What are the differences between PAYE and umbrella?

The main difference between PAYE vs umbrella is the way that contractors operate under each.

Whereas with an umbrella company, contractors are free to find their own contract work, choose which clients they work with and decide when they will take on work and when, under a PAYE agency contractors do not have a choice over what contracts they work on.

This makes the umbrella company route a very appealing option to many contractors, giving them the same degree of freedom and flexibility as a self-employed, limited company contractor, coupled with the security of being employed by the umbrella company.

Another main difference between the two options is continuity of employment.

Whereas an umbrella company offers contractors continuity of employment, meaning one handy tax code, a PAYE agency does not. This can make things such as getting a loan or a mortgage a lot harder for PAYE contractors.

Finally, another key difference between the two is the ability to claim for expenses.

Whereas most umbrella companies allow contractors to claim back legitimate business expenses, typically PAYE agencies do not.

Expenses can usually be offset against your tax bill, meaning the ability to claim expenses is considered a big advantage of umbrella companies by many contractors.

Self-assessment

There is also a third option – self-assessment. Here, the contractor will work on a self-employed basis, typically through a limited company.

With this option, contractors work off-payroll, meaning they carry out self-assessment and are responsible for making their own tax and National Insurance contributions. They still pay the same amount of tax, it is just processed and paid differently.

This option offers complete freedom to contractors to operate as they wish. However, it does also mean the contractor is responsible for running their own business, working out often complex tax returns, business admin and paperwork and a host of other things that are all part and parcel of running a business.

What’s more, with recent reforms to IR35 legislation that came into action from April this year, many contractors are moving away from the limited company route in order to avoid getting caught out.

PAYE vs umbrella: Which is the best option for you?

Having weighed up your options and explored the key differences between PAYE vs umbrella, contractors can make a well-informed decision about which option is route is best for them.

If you have chosen the umbrella company route, like thousands of other contractors, the next step is to find the best umbrella company for your needs.