In addition to your personal income tax liability, if your contracting salary is above the prevailing thresholds, both you and your company (limited or umbrella) will need to pay National Insurance Contributions to HMRC.
The National Insurance system was originally put in place to insure workers against sickness and unemployment. In recent years, National Insurance Contributions have raised an increasing proportion of total UK Treasury receipts, and the system is seen by many as an additional income tax in all but name.
During the 2014-15 tax year, for example, the Treasury raised just over £109bn from National Insurance Contributions (over 20% of total Treasury receipts), compared to around £163bn from ‘Income Tax’. In fact, in the previous tax year, more money was raised from National Insurance than from VAT.
All UK employers must pay Employers’ NICs on salaries paid to their employees, and the employees themselves must pay Employees’ NICs on any income they earn.
Here, we look at how NICs are calculated, for both employers and employees. This article has been updated for the 2016/17 tax year.
National Insurance for Employees
If you’re a contractor, you will be an employee of your own limited company, an employee of an umbrella company employer, or in some cases, a PAYE employee of an employment agency.
Class 1 NICs are payable on any salaried income you receive, regardless of the business structure you work under.
During the 2016/17 tax year, employees must pay NICs of 12% on income falling between £155 and £827 per week, and at 2% on income above £827 per week.
You must pay 12% NICs on salaried income falling between this ‘primary threshold’ (£8,060) and £43,000, and 2% on any additional income above £43,000.
If you’re working via an umbrella company or an a PAYE basis with an agency, income tax and NICs will be deducted at source and paid to HMRC on your behalf.
If you’re working via your own limited company, you have more flexibility over your exposure to National Insurance. Most limited company contractors elect to pay themselves small salaries (either below, or just above the prevailing NIC ‘primary threshold’) in order to minimise their NIC liabilities. National Insurance Contributions are not payable on company dividends.
National Insurance for Employers
All employers must pay Class 1 NICs on the salaries they pay to their staff.
If you’re working via an umbrella scheme (or contracting directly with an agency), then your employer will allow for employers’ NICs at source from your gross fees.
If you are contracting via your own limited company, the company must pay employers’ NICs on any salary payments.
For the 2015/16 tax year, employers’ NICs apply to salaries of over £156 per week at a rate of 13.8%.
If you annualise the weekly £156 threshold, no Employers NICs are payable if you draw an annual salary of £8,112 or less.
In April 2014, a new Employment Allowance was implemented, which refunds the Employers’ NICs paid by limited companies to their employers up to a maximum of £3,000 per year, which results in a saving to contractors who pay themselves a salary above the £8,112 Employers NIC threshold. Try this calculator to find out how much this new incentive will save you (via GOV.UK).
Other Types of National Insurance
The ‘self employed’ pay Class 2 and Class4 NICs. Class 2 liabilities are paid via self-assessment (the rate is currently £2.80/week on earnings of £5,965 or more per year), and are expected to be abolished in the near future.
Class 4 liabilities are worked out via the self-assessment process each year. The current Class 4 rate is 9% on annual profits of between £8,060 and £43,000 per year, and 2% on amounts above £43,000.
It should be noted that is very unusual for IT contractors to work on a ‘self employed’ basis. The vast majority will be liable to pay Class 1 contributions only.