National Insurance Contributions (NICs) are payable whether you are self-employed or employed by your own company, although different rules and rates apply. National Insurance contributions can significantly increase the amount of tax you pay.
Although it can affect your entitlement to some state benefits, you will almost certainly want to minimise the total National Insurance contributions you and your business pay.
Effective tax planning may allow you to reduce your National Insurance contributions, so seek professional advice – an accountant can help you as part of your overall tax planning.
National Insurance contributions for the self-employed are in two parts. You pay a flat rate of Class 2 National Insurance contributions regardless of how profitable your business is (though low-earning businesses can be exempted altogether). The Government has announced that Class 2 NICs will be abolished in the course of this parliament.
You also pay Class 4 National Insurance contributions calculated as a percentage of your annual profits above a basic threshold.
National Insurance contributions are calculated and collected as part of your self-assessment tax return. While the detailed calculations will vary, total National Insurance contributions for the self-employed might be about 10% of earnings.
Both employers and employees have to pay Class 1 National Insurance contributions. National Insurance contributions are collected through the PAYE system used for payroll tax deductions.
Employers pay Class 1 National Insurance contributions as a percentage of any employee’s earnings above a basic threshold. Employers also pay Class 1A National Insurance contributions on any taxable employee benefits they provide.
Employees also pay Class 1 National Insurance contributions on their earnings above the threshold. The rates used to calculate employees’ and employers’ National Insurance contributions differ, but the total combined charge typically represents a rate of more than 20% on earnings above the threshold.
The Government has introduced the Employment Allowance, which means that eligible businesses will receive a reduction on their employer's National Insurance Contributions (NICs) each time they run their payroll. The allowance reduces the amount of NICs payable until the allowance has been used up. The allowance is £3,000 from April 2016 (previously £2,000).
The allowance is simple to claim using payroll software. Each time you submit an employment payment summary to HMRC simply select 'Yes' in the 'Employer Allowance Indicator' field as part of your PAYE real time reporting.
The different rates of National Insurance contributions can mean you will pay less if you are self-employed rather than an employee of your own company.
If you operate as a company, you may be able to draw money in the form of dividends. Tax and National Insurance is not payable on dividend income up to the dividend allowance threshold of £5,000. Dividend income over the initial allowance is subject to tax (7.5% for basic rate tax payers, 32.5% for higher rate payers and 38.1% for additional rate payers). But special anti-avoidance rules mean that in some circumstances payments like this are taxable (and subject to National Insurance contributions) in the same way as employment income.
The most tax-efficient option will depend on your exact circumstances, and how the different tax rates and thresholds affect not only National Insurance contributions, but also income tax and/or corporation tax. You should also bear in mind that the legal structure of your business can have other important consequences, such as whether you could be held personally liable for business debts.