Sarah Bradford explores the impact of the Chancellor’s announcement that from next year one-man companies will no longer be able to claim the NIC employment allowance.
The National Insurance employment allowance was introduced from April 2014 and provides employers with a reduction in their secondary Class 1 National Insurance bill up to the amount of the allowance. The allowance was set at £2,000 for 2014/15 and 2015/16.
In his summer 2015 Budget the Chancellor announced that the allowance is to be increased to £3,000 a year from April 2016. However, from that date, companies where the director is the sole employee will no longer be able to benefit. The loss of the allowance will affect the calculation of the optimal salary calculation for personal companies.
Optimal salary – 2015/16
It is generally efficient for a tax and National Insurance perspective for a director of a one-man company to pay a small salary to preserve the director’s entitlement to the state pension and certain contributory benefits and to withdraw any remaining profits as dividend. To preserve pension entitlement the salary must be at least equal to the lower earnings limit for National Insurance purposes. For 2015/16 this is set at £112 per week. This means that the annual salary must be at least £5,824 for this tax year.
As employee Class 1 National Insurance contributions are payable at a notional zero rate, it is possible to pay a salary of up to £8,060 (the annual level of the primary threshold) for 2015/16 free of both tax and National Insurance, as long as the director’s personal allowance remains available.
Once the salary level exceeds £8,060 the director will have to pay Class 1 National Insurance contributions of 12%. Normally, employer contributions of 13.8% would also be payable once the salary exceeds the level of the secondary threshold, set at £8,112 for 2015/16. However, as one-man companies can currently claim the employment allowance, the employer does not pay any contributions until the NIC bill for the year exceeds £2,000. The impact of the allowance means that as the personal allowance is available, for 2015/16 it is better to pay a salary of £10,600 and pay employee’s National Insurance of £304.80 than to pay a salary of £8,060 and take the rest of the profits as dividends. At this salary level, no employer National Insurance is due as it covered by the annual allowance. However, as the salary is deductible for corporation tax purposes, the additional salary of £2,540 paid above the primary threshold saves corporation tax of £508 (£2,540 @ 20%) for the cost of the employee’s NIC of £304.80 – a net saving of £203.20.
It is not worth paying a salary in excess of the personal allowance, despite the employment allowance, as any salary above this level will be taxed. The combined effect of the income tax and employee’s NIC will outweigh the corporation tax deduction.
Optimal salary – 2016/17
For 2016/17, the employment allowance will not be available to one-man companies where the director is the sole employee. Where this is the case, the benefit of paying a salary in excess of the primary threshold is lost (other than to the extent that the secondary threshold is higher than the primary threshold) as the combined employee and employer National Insurance cost will outweigh the corporation tax deduction.
Tip:
From April 2016, in one-man companies where the director is the sole employee, the loss of the employment allowance means that the optimal salary for 2016/17 is one equal to the higher of the primary threshold and the secondary threshold. The loss of the employment allowance from 2016/17 means that it is no longer beneficial to take a salary once both primary and secondary contributions are payable. If only primary contributions or only secondary contributions are payable, the NIC hit is offset by the corporation tax deduction.
However, for companies that have other employees the employment allowance remains available next year and it will continue to be beneficial to pay a salary up to the personal allowance (set at £11,000 for 2016/17) as long as this remains available.
Practical Tip:
If the director is under 21, it will remain beneficial to pay a salary equal to the personal allowance, as where the employee is under 21 no employer’s NIC is payable at this level.
Note:
The rules for taxing dividends are reformed from 2016/17 and this will impact on the dividend strategy.
