Quick Menu
Income Tax & National Insurance
As the Director of your own Contractor Limited Company you have the right to decide how much you pay yourself in salaried income and how much you receive in company dividends (where outside IR35). National Insurance costs can be minimised by taking a low salary, a small expense package and a large proportion of income in company dividends but this is not possible where caught by IR35. If caught by IR35 you will need to take contract income in the form of salaried income on which full income tax and class 1 national insurance payments are due.What levels of Income Tax and National Insurance is applied to salary?
In the UK income from employment is taxed at source and paid directly to the government by the employer. The Pay as You Earn (PAYE) system is the government’s means of collection. Before a net salary payment can be made Income Tax and Class 1 National Insurance must be deducted. There are two types of Class 1 National Insurance payable:- Class 1 Employees National Insurance
- Class 1 Employers National Insurance
Employees National Insurance is payable by an employee on salaried income. It is levied at a rate of 12% between the primary threshold and the upper earnings limit. Any Income above the upper earnings limit is taxed at a rate of 2%. Therefore a ‘cap’ is in place to reduce the level of national insurance paid by high earners.
Employers National Insurance is payable by the employer on an employees salary and benefits. Benefits may include a company car, health club membership etc but are unlikely for freelance contractors running Limited Companies. Employers National Insurance is levied at a flat rate of 13.8% above the secondary threshold; there is no upper limit or ‘capping’.
For limited company contractors the biggest National Insurance saving will be on Employers National Insurance. Unlike Employees National Insurance which involves a cap at the upper earnings limit, Employers National Insurance is uncapped.
Income Tax and National Insurance rates for 2011/2012
The financial year is from the 6th of April to the 5th April.Income Tax
| Description | Rate of Tax | Taxable Band |
|---|---|---|
| Basic Rate | 20% | £0 – £35,000 |
| Higher Rate | 40% | £35,001 - £150,000 |
| Top Rate | 50% | Over £150,000 |
Those earning under £114,950pa will have a ‘personal allowance’ that can be earned before any tax is due. For those earning under £100,000pa, this personal allowance is usually £7,475pa (those aged 65+ have a higher allowance http://www.hmrc.gov.uk/rates/it.htm). For earnings above £100,000pa, £1 of personal allowance is lost for every £2 of earnings above £100,000, until (for those under 65) earnings reach £114,950pa at which point the personal allowance will have disappeared entirely.
The tables below summarise the positions for those on up to £100,00pa and those on over £114,950pa. Those between these two figures face a more complex situation that does not lend itself readily to beig tabulated.
Income Tax rates for someone earning under £100,00 pa
| Description | Rate of Tax | Paid on earnings |
|---|---|---|
| Personal allowance | 0% | £0 - £7,475 |
| Basic Rate | 20% | £7,476 – £42,475 |
| Higher Rate | 40% | £42,476 - £100,000 |
Income Tax rates for someone under 65 earning over £114,950 pa
| Description | Rate of Tax | Paid on earnings |
|---|---|---|
| Personal allowance | 0% | n/a |
| Basic Rate | 20% | £0 – £35,000 |
| Higher Rate | 40% | £35,001 - £150,000 |
| Top Rate | 50% | Over £150,000 |
Those earning between £100,00pa and £114,950pa face a particularly high marginal tax rate. They are already paying 40% tax on the marginal earnings, but when this is combined with the loss of £1 of personal allowance for every £2 earned, this has the effect of causing the £1 that was previously untaxed, to be taxed at 40%; as £2 earned causes 40p of tax, for each £1 earned there is an extra 20p of tax through the removal of the personal allowance, as well as the 40p of tax on the ‘extra earnings’, so the marginal tax rate is 60%. Add in employee’s NI at 2% and you are loosing 62% of each extra £1 earned. For someone on PAYE, whose employer is paying 13.8% Employer’s National Insurance, the situation is even worse. The company has to spend 113.8pence to put 38pence in the employee’s pocket. This leaves the employee with 33.4 pence for every £1 spent by the employer; a combined tax & NI cost of 66.6%! Anyone facing this situation should consider options such as a pension; the tax relief will mean that for every £3 put into the pension, you get almost £1.80 of tax relief
Employees Class 1 National Insurance
- 0% below the Primary threshold of £136 per week
- 12% between the Primary threshold (£136 pw) and the Upper Earnings Limit (£817 pw)
- 2% on earnings above the Upper Earnings Limit of £817 per week
Employers Class 1 National Insurance
- 0% below the Secondary threshold of £139 per week
- 13.8% above the Secondary threshold of £139 per week
