National Insurance is a deduction from earnings, set up originally to fund various State benefits such as the NHS, the State pension and other welfare-related schemes.
In reality, it is just another tax. In fact, as standard income tax rates have remained constant for many years, NI rates have soared.
In this article we look at how NI works, and what your National Insurance Contributions (NICs) will be as a small business person. The guide has been updated with the 2013/14 tax year NIC rates.
Overview of National Insurance Types
Class 1 – Paid by employees and employers. These are calculated as a percentage of your wages, up to an upper earnings limit. This is the most common NIC type. The primary contribution is paid by the employee, the secondary by the employer.
Class 1A – A ‘special rate’ paid by your employer if you get certain benefits with your job, such as a company car.
Class 2 – A compulsory rate paid by the self-employed. You are exempt if your earnings are below a certain limit.
Class 3 – Voluntary Contributions. You can pay these to help fill gaps in your national insurance contribution record. HMRC may get in touch with you to suggest to top up your contributions.
Class 4 – You may have to pay Class 4 contributions if you are self-employed and your profits are over a certain amount each year.
Sole Traders and the Self-Employed
Sole traders pay income tax on their business profits (as self-employed individuals). In addition to PAYE (income tax), they are liable to pay National Insurance contributions (NIC’s).
Sole traders pay Class 2 and Class 4 NIC’s and are liable to pay contributions from the first day of self-employment.
NIC’s are deducted from your gross earnings, assuming the figures are above the lower earnings threshold.
Individuals who run a business via a partnership arrangement are taxed in the same way as sole traders.
Class 2 Contributions are £2.70 per week [2013/14], and are paid by anyone earning £5,725 ore more during the tax year.
Class 4 Contributions are paid on any profits you make as a self employed person. The rate paid is 9% of all earnings between £7,755 and £41,450 p.a., and 2% above £41,450 p.a.
Limited Company Directors
Unlike sole traders, for tax purposes, if you are a director of a limited company, you are an ‘employee’ of the company. You are therefore liable to pay Class 1 NIC’s on your earnings. The limited company is also liable to pay Class 1 NIC’s as your ‘employer’.
Employees (Primary Class 1 Contribution) pay 12% on earnings between £149 and £797 per week, and 2% above £797 per week [2013/14].
Employers (Secondary Class 1 Contribution) pay 13.8% on earnings above £148 per week [2013/14].
These NIC deductions should be paid to HMRC by the 19th of each month, unless payments are low, where you may be able to pay quarterly.
Limited Company directors and other employees may also have to pay Class 1A NIC’s for ‘benefits in kind’ such as company car provision. Your accountant will declare such benefits each year on your P11D form.
You will typically be allowed a few extra days beyond the traditional cheque deadlines if you pay your liabilities electronically.