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.
How is employee Gross Pay calculated?
To work out an umbrella employee’s gross pay, first you need to deduct ’employment costs’, any pension contributions, and the umbrella company’s fee from the amount invoiced to the recruitment agency.
The employment costs consist of Employers’ NICs and the Apprenticeship Levy. These statutory costs will have been factored into your assignment rate when you took up a contract role.
Once these employment costs, any pension contributions, and the umbrella margin have been deducted, you are left with your gross pay upon which personal taxes are applied. This is the pay rate you should have agreed when you started the contract role.
National Insurance Contributions (NICs)
There are 2 types of National Insurance Contributions – employees’ and employers’ NICs.
The umbrella company deducts employers’ NICs from the value of any invoices submitted to your client or agency (one of the ’employment costs’ mentioned above).
You will then have to pay employees’ NICs on your income.
For the 2023/4 tax year, employers’ NICs apply to salaries above £9,100 at a rate of 13.8%.
You pay employees’ NICs at 12% between £12,570 and £50,270, and 2% above £50,270.
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 1257L tax code (2023/4 tax year) means that you will not be taxed on any of your income below the £12,570 mark (the current ‘Personal Allowance’).
After the Personal Allowance is taken into account (£12,570 – if you are eligible for the whole amount), the next £37,700 of income taxed at 20% (the ‘basic’ rate).
Income from £37,700 to £124,100 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 £50,270.
For earnings over £100,000 per annum, the tax-free allowance is reduced by £1 for every £2 over £100,000 that is earned. Earnings over £125,140 are taxed at 45%.
PAYE umbrella company expenses
The other consideration with an umbrella company is that you may 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 decides what can be claimed as an expense and not your umbrella company, and the scope for claiming expenses has been massively reduced in recent years.
The only difference in take-home pay between all the umbrella companies in the marketplace 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. This 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.
Read our guide to classic net take-home pay calculation tricks used by some unethical umbrella providers.