Why 45,000 is the magic number for a PSC turned brolly

Thousands of temporary professionals are being given no choice but to use umbrella companies in wake of the April 6^th off-payroll rules in the public sector, writes Carolyn Walsh of Andraste Accounting. Is there a means of escape from this taxing migration?

Before I set out my evidence for a ‘yes’ answer (of sorts), first some reflection. For the first time ever, HMRC has given clear and interactive guidance on when someone contracting through their own limited company does not fall foul of IR35, in the shape of the ESS, aka the IR35 digital tool.

Despite this progress in the status space, thousands of contractors are now contemplating their fate as they become umbrella company employees, foisting on them an employer they never wanted and complicated tax affairs that are regularly misunderstood.

Contractors can’t simply walk away from their contracts so it seems their hands are tied. We are where we are. But this resignation belies the fact that there are actually some important steps that can be taken to minimise the financial damage of going from a tax-efficient PSC keeping IR35 at bay -- to a PSC who’s become an umbrella company worker due to the new IR35 rules and who’s paying an “unnecessary” amount in tax.

When an agency pays a worker via an umbrella company, the rate is subject to certain deductions at source, so the employment income. This is the amount of pay that is subject to tax and NICs, and it’s simply the combined amount of holiday pay and basic pay shown on an umbrella company payslip. Always ignore the other figures, they're just noise.

Any good accountant will tell you that most tax-efficient manner of being paid for any UK taxpayer (and this is especially true for an umbrella company worker), is to limit employment income to £45,000 per year. Holiday pay is generally paid on a week-by-week basis by an umbrella company, which means most umbrella company employees will take 4-6 weeks unpaid leave each year. So for example, contractors earning rates of up to £30 per hour and limiting the working week to 37 hours will accrue employment income of less than £45,000 per year when taking 5 weeks off per year.

The reason why a strategy of limiting employment income paid via an umbrella company is vital for the financially shrewd is this; when paid by an umbrella company, the total deduction for PAYE, employee and employer NICs is 36%, but for every one pound of employment income that is earned over the level at which taxpayers pay tax at 40% (this tax year that's £45,000), the umbrella company will deduct a whopping 65% in PAYE and NICs!

By adopting the above strategy, umbrella company employees can lawfully minimise PAYE and NI deductions. And taking this further, adopting the strategy of say, working 40 weeks per year as an agency/umbrella company employee, provides time to take some holidays; work on a self-employed basis for a month or so for a different hirer or even freelance in a different industry. A change is as good as a rest, so they say.

In industries where agencies disregard prevailing tax law and turn to umbrella companies no matter what the situation, workers need to first know what they are being paid for their labour and services, i.e. what their employment income actually is. Then, where possible, limit that employment income to £45,000 in 2017/18. Or if not, they can simply throw both their valuable time and money away. As with most injustices, people will learn to adjust to the unfairness brought on by these IR35 reforms, but the best thing to do right now is to use the system both lawfully and wisely.

Editor’s Note: Related Reading –

PSCs, verbal IR35 assurances aren’t reliable

Moving from a PSC to an umbrella: is it worth it?

Why umbrellas aren’t a must for IR35-caught PSCs