Following the introduction of the MSC legislation, if you choose to receive your payments through a third party rather than managing your own limited company, your payments must be processed through PAYE.
PAYE stands for Pay As You Earn which means that, as a contractor, you will pay your tax and National Insurance contributions as you go along in exactly the same way as a permanent employee.
PAYE calculations are determined by HMRC, with both income tax and national insurance contributions being deducted as a percentage of your earnings.
National Insurance Contributions (NICs)
There are 2 types of National Insurance Contributions – employees’ and employers’ NICs.
The umbrella company will deduct employers’ NICs from the value of any invoices submitted to your client or agency.
You will then have to pay employees’ NICs on your income.
For the 2017/18 tax year, both type of NICs are payable on earnings above £157 per week – at 12% (employees’) and 13.8% (employers’).
Employees’ NICs above the £866 per week threshold are are 2% of earnings.
Income tax deductions
You pay income tax on all income you receive above the personal threshold. The amount of income you can receive before paying any tax is determined by your tax code.
For example, the 1150L tax code (2017/18 tax year) means that you will not be taxed on any of your income below the £11,500 mark (the current ‘Personal Allowance’).
After the Personal Allowance is taken into account (£11,500 – if you are eligible for the whole amount), the next £33,500 of income taxed at 20% (the ‘basic’ rate).
Income from £33,500 to £150,000 is taxed at 40%, and any income received above this threshold is taxed at the ‘additional’ 45% rate.
So, you only start paying higher rate (40%) tax if you earn over £45,000.
For earnings over £100,000 per annum the tax free allowance will reduce by £1 for every £2 over £100,000 that is earned. Earnings over £150,000 are taxed at 45%.
PAYE umbrella company expenses
The other consideration with an umbrella company is that you will be able to claim certain costs as expenses.
Any expenses that are to be refunded to you by your recruitment agency or end client are known as ‘chargeable expenses’.
Any other expenses are known as ‘non chargeable’ and will be processed by your umbrella company when calculating your weekly or monthly pay.
Your taxable income will be reduced by the value of any allowable expenses, and you do not pay tax on the value of your expenses.
You should remember that HMRC decide what can be claimed as an expense and not your umbrella company. The only difference in take-home pay between all the umbrella companies in the market place should be caused by differences in the fees that they charge and, obviously service levels.
Beware ‘higher net pay’ umbrella company claims
Finally, and this is vitally important, ALL Umbrella Companies operate under the same rules and regulations which means that there are no magical formulas, no elaborate schemes and no creative accounting that allows one company to give you a higher net pay than another.
This article is an updated version of an original piece written by Russell Duke from Contractor Umbrella.