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  • Writer's pictureUmbrella Search

PAYE vs. umbrella: what are the key differences?

Updated: Feb 8, 2023

Every contractor across the UK will have to choose between working through PAYE or an umbrella company.

This will significantly impact the contractor's daily life, meaning it's essential that contractors research to find the best option for them.

To help, Umbrella Search has put together this handy guide explaining the key differences between PAYE vs. umbrella to help every contractor make an informed decision that's best for them in 2023.

PAYE explained

PAYE stands for pay-as-you-earn, which is the most common way that workers in the UK pay tax.

With the PAYE tax system, tax and National Insurance contributions are taken from a worker's salary before it is paid to them, meaning they are always up to date with their tax affairs.

As we have mentioned, this is the most common way that workers in the UK pay tax. The exception is for off-payroll workers, such as the self-employed, who will instead fill out a self-assessment either monthly, quarterly, or annually once their income and expenses have been processed.

Those that pay tax through the PAYE system will be taxed in line with current tax bands, which for the April 2022 – April 2023 tax year are as follows:

  • Tax-free Personal allowance: up to £12,570 per year

  • Basic rate (20%): £12,571 - £50,270 per year

  • Higher rate (40%): £50,271 - £150,000 per year

  • Additional rate (45%): over £150,000 per year

  • Tax-free Personal allowance: up to £12,570 per year

  • Starter rate (19%): £12,571 – £14,732 per year

  • Basic rate (20%): £14,733 - £25,688 per year

  • Intermediate rate (21%) £25,689 - £43,662 per year

  • Higher rate (41%) £43,663 - £150,000 per year

  • Top rate (46%): over £150,000 per year

  • Tax-free Personal allowance: up to £12,570 per year

  • Basic rate (20%): £12,571 - £50,270 per year

  • Higher rate (40%): £50,271 - £150,000 per year

  • Additional rate (45%): over £150,000 per year

What is an umbrella company?

Option 1 – PAYE

That's what PAYE refers to, but what does this mean for contractors?

Contractors who operate through a PAYE agency will pay their taxes through the PAYE tax system. However, there are some key differences when working with a PAYE agency than if the contractor was working through an umbrella company.

The first is how the contractor will operate on a day-to-day basis. After all, PAYE agency contractors can't choose which contracts they work on. Instead, the agency will find and secure contractors for the contractor.

Although this may make contractors' lives a little easier, it does mean they may end up working on contracts they wouldn't choose. It also means that contractors will only be in charge of their career progression, which is a drawback for many.

Next, contractors operating through a PAYE agency need to receive continuity of employment. This means that PAYE agency contractors don't receive one tax code, making it much easier to secure credit and take out a loan or mortgage. This can put contractors at a disadvantage if they are at the stage where they are planning to buy a new home or require things like credit cards.

Finally, another factor to consider when looking at the PAYE route is that most PAYE agencies don't allow contractors to claim back legitimate business expenses.

Again, this is widely considered a disadvantage for contractors as expenses can be offset against the contractor's tax bill.

Option 2 – Umbrella Company

That's the PAYE option; now, let's look at the umbrella company option.

As with a PAYE agency, contractors working through an umbrella company will pay tax in line with the PAYE system. So, if contractors are paid the same way and contribute their taxes in the same way, what are the key differences between PAYE and umbrella?

Firstly, unlike a PAYE agency, umbrella company contractors can choose which contracts they work on and when. Although this means that contractors have to take the time to secure their work, it does mean that they can win the contracts they want with the clients they want to work with.

For this reason, many contractors prefer the freedom to choose their work as it puts their career progression in their own hands, meaning they can go for those all-important high-value contracts.

The next difference between umbrella and PAYE is that contractors receive continuity of employment with an umbrella company. As discussed, this makes it easier for contractors to secure things like mortgages and credit.

Finally, umbrella company contractors can claim back business expenses meaning they can pay less tax by offsetting these against their tax bill.

Umbrella vs. PAYE – which is best?

Now that we've outlined the key differences between PAYE and umbrella, contractors can decide which option is better.

For contractors that want the freedom and flexibility to choose which contracts they want to work on and when they want to have control over their career progression, continuity of employment, and the ability to offset expenses against their tax bill, an umbrella company will be the best option.

If this is the case, the next step will be to find an umbrella company that's just right for your contracting needs. After all, there are many companies to choose from, so it can be challenging to know which option will be the best.

Thankfully, Umbrella Search is here to help.

Find the best umbrella company with Umbrella Search

At Umbrella Search, we work closely with contractors to understand what they require from an umbrella company, whether that's same-day payments, help with filing expenses, or advice on childcare tax credits.

Whatever you need, we compare umbrella companies to find the best, most suitable one for your needs.

To see how we can help and to take the first steps in finding your perfect umbrella company, get in touch with our friendly team for a quote, and we will get back to you as soon as possible.

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