Income Tax and 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 11% between the primary threshold, £5,460 (annual) and the upper earnings limit, £40,040. Any Income above the upper earnings limit is taxed at a rate of 1%. 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 12.8% above the secondary threshold of £5,460 (annual); 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 2008/2009

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 – 36,000
Higher Rate	40%	Over 36,000

Employees Class 1 National Insurance

1. 0% below the Primary threshold of £100 per week
2. 11% between the Primary threshold (£105 pw) and the Upper Earnings Limit (£770 pw)
3. 1% on earnings above the Upper Earnings Limit of £770 per week (£40,040 per annum)

Employers Class 1 National Insurance

1. 0% below the Secondary threshold of £105 per week (£5,460 per annum)
2. 12.8% above the Secondary threshold of £105 per week (£5,460 per annum)

The combined effect of Income Tax and National Insurance

Earnings	ITR	ENI	Combined	Average	Total Deduction
£0 to £5,435	0%	0%	0%	0%	Nil
£5,436 to £41,435	20%	11%	31%	0% - 26.93%	£0.01 to £11,159.69
£41,436 +	40%	1%	41%	-	-

ITR = Income Tax Rate, ENI = Employees National Insurance, Combined = Combined Marginal Income Tax and Employees National Insurance, Average = Average Rate of Combined Income Tax and Employees National Insurance, Total Deduction = Total Income Tax and Employees National Insurance Paid

Why many contractors with 1 man companies pay themselves a low salary

If you set a low salary of around £12,000 and take remaining contract billings in the form of company dividends you can save Class 1 National Insurance costs (National Insurance is a tax in all but name). A £12,000 salary would take up your personal allowance (0% tax), and some of your basic rate tax band (20%). In terms of National Insurance you would pay 11% Class 1 Employees National Insurance and 12.8% Employers National Insurance above the Primary and Secondary thresholds respectively. The remainder of your income (above £12k) would be taken in the form of dividends. 20% Corporation Tax (small company rate) must be paid on company profits before a dividend can be issued (note in 2009-10 the corporation tax rate rises to 21%). Contractors with income below the higher rate tax band do not have any further liability. Contractors with income above the higher rate tax band will have a higher rate tax liability payable once a tax return is completed. For further information on see ‘UK Dividends’

To find out more about going into business with your own Limited Company call Commonwealth Contractors now on 0800 294 4388 or submit your details and we will get right back to you

Related Contractor Ltd Companies Pages:

• Contractor Limited Companies
• • Contractor Limited Companies
  • IR35 Assessment Tool
• Managed Service Companies
• • Managed Service Companies
  • MSC Involvement
• UK Dividends
• • Freelance Contractors and UK Dividends
  • Calculating and Paying Dividends
  • Dividend Tax
• Income Tax and National Insurance
• • Setting a Salary
  • Registering for PAYE
  • Income Tax and National Insurance
  • PAYE Payments and Returns
  • PAYE Investigation
• Business Expenses
• • Claiming Business Expenses
  • Contractor Expenses
  • Home Based Rules and Business Expenses
  • IR35 and 5% Expense Rule
  • Site Based Rules and Business Expenses
• VAT Guide
• • VAT Guide for Contractors
  • The VAT Flat Rate Scheme
• Timesheets, Invoices and Payments
• • Contractor Timesheets
  • Limited Company Invoices
  • Client and Agency Payments
• Section 660 and Income Shifting
• • Section 660a and Income Shifting
  • Section 660a Background
• Dealing with Contracts Inside and Outside IR35
• UK Corporation Tax
• Directors Duties and Responsibilities
• Opening a Limited Company Bank Account
• Loans and Mortgages
• Contractor Limited Companies and UK Immigration