Contractors now make up a large percentage of the UK workforce. It is a popular route for many due to the flexibility that this kind of employment offers. However, contractors can be paid a few different ways, namely through the PAYE system (Pay as You Earn), or via an umbrella company. There are notable differences between these two systems, some of which are often overlooked. Thus, when faced with the choice, contractors should do their research and find out exactly which option is right for them. So, let’s go through each system’s basics and find out the main differences that contractors should be aware of. In this article we take a look at PAYE vs. Umbrella and the difference for contractors.
First, let’s go through the Pay as You Earn system. This one is fairly self-explanatory, and it is the most well-known – and most common – way to pay tax. This is how traditional employees pay tax. It’s is all done by their employer as they earn money, hence the name. Every staff member on a business’ payroll will have their taxes and national insurance contributions deducted at the same time they get paid. This contrasts with off-payroll workers, who will fill out self-assessment forms and pay their own taxes directly. If you are a contractor and choose to work for a PAYE agency, the same rules will apply. You will pay all of your tax and national insurance contributions at the source before you are paid.
Next, let’s consider the umbrella option. This is a less well-known option for contractors, but it can be beneficial for several reasons. However, there are also similarities between the umbrella and PAYE, with the main being that all tax and national insurance is still paid through PAYE. But the difference is it is an umbrella company the contractor works for, rather than a traditional employer. While they earn a salary and pay their tax and NIC through PAYE, there are some major differences in the work they carry out.
When a contractor works for a PAYE agency, the contractor must do the work they are given. They will also need to work to the agency’s specific timelines and thus are limited when it comes to flexibility. This is where the umbrella system really has the advantage. When working for an umbrella agency, the contractor has far more flexibility, choosing the contracts they take on and which clients they want to work for. This means they have a sense of being self-employed in the traditional sense. They can take whichever career paths take their interest.
The second difference is regarding the ability to claim for expenses. Expenses are a big part of being self-employed, allowing contractors to claim back money they have spent on their work-related activities. This can make life much easier and save contractors a lot of money. Umbrella agencies tend to offer the ability to claim expenses to their contractors. However, it is rare for a PAYE agency to do this, and thus it can be an important consideration for contractors to make.
Finally, there is the issue of continuity of employment. This essentially means the contractor only has one tax code, rather than switching between tax codes depending on their current fluctuating work situation. Umbrella agencies tend to offer this, while PAYE agencies tend not to. This is a major consideration for those thinking of applying for loans or mortgages.
We mentioned self-assessment earlier about off-payroll employees. Self-assessment is the government’s scheme for self-employed people to fill out their tax returns each year. This option offers contractors the most flexibility. They are essentially free to do what they want when it comes to work and clients. However, it also comes with the most responsibility, requiring the contractor to fill out self-assessment tax returns each year and run their business daily. This option is not for everyone, but the freedom it offers is ideal for some.
This idea of flexibility is usually the deciding factor for choosing which option is the right one for you. Contractors that value ease of use and simplicity might prefer to go for the traditional PAYE system as they will take care of everything tax-related for you, and you have to do what they say when it comes to working. Those who want the freedom of doing their own thing might opt to go for the self-assessment route, as it gives you the most freedom and the most responsibilities. This is why the umbrella options serve as good middle ground, benign the popular choice for contractors that want the best of both worlds, with increased flexibility but simplified taxes.
Knowing the difference between PAYE vs. Umbrella is vital to ensure you make the right decision and reach your potential as a contractor.