Class 1 National Insurance contributions (NICs) are paid by employees and by employers on their employees’ earnings. For most employees, their (primary) contributions are deducted from their salary for each pay period, and the employer also pays a separate (secondary) contribution on top. Directors may be employees if they have a contract or service agreement. If not, they will be classed as an office holder.
For NICs purposes, a director is any person who is formally appointed as a director of a company, or who acts as a director, even if not officially registered as such. This includes executive and non-executive directors, shadow directors, and de facto directors. The director’s status is significant because it determines the method used to calculate their NICs.
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Annual or standard earnings periods
Unlike ordinary employees, directors’ Class 1 NICs are usually calculated on an annual earnings basis rather than by reference to the weekly or monthly pay period. This reflects the fact that directors’ pay can be irregular, with bonuses or dividends often paid at various points throughout the year.
Historically, this allowed directors to pay themselves a small (say, monthly) salary below the monthly NICs threshold and then a large annual bonus. To counteract this, the default method for directors is now the annual earnings period. This means that the NICs thresholds and rates are applied to the director’s cumulative earnings from the start to the end of the tax year, regardless of how often they are Paid.
Calculating Class 1 NICs for directors
Generally, directors who may be paid irregularly should have their NICs calculated on cumulative earnings through the year and apply the relevant thresholds and rates. Because directors’ NICs are calculated on a cumulative basis, the deductions may be higher or lower in particular months, depending on total earnings to date. Directors should be aware of this to avoid unexpected liabilities that reduce net pay. Alternatively, if directors are paid regularly, NICs can be calculated like those of a regular employee for each pay period. However, at the end of the tax year, the NICs calculation is reconciled to ensure the correct total has been paid. The method used must be notified to HMRC in the relevant field on the PAYE full payment submission (see: www.gov.uk/employee-directors).
Directors’ NICs rates and allowances
Directors pay the same rates of Class 1 NICs as other employees: 12% on earnings between the primary threshold and upper earnings limit; and 2% on earnings above the upper earnings limit. Employers pay 13.8% on earnings above the secondary threshold, with no upper limit. These rates are set by the government and may change each tax year.
Key considerations
Employers are entitled to the annual employment allowance of up to £10,500 to reduce their secondary NICs. But one-person companies should note that this will not be given if secondary NICs are paid for only one person. Employers must ensure that NICs for directors are calculated correctly and reported via the PAYE system. Care should also be taken when payments are charged to a director’s account, particularly if this is overdrawn. Further, if a person is remunerated separately as a director and an employee, these earnings must be aggregated for NICs calculation Purposes.
Conclusion
Class 1 NICs for directors is a complex area with unique calculation rules and compliance requirements. By understanding the annual earnings basis, keeping accurate records, and monitoring cumulative pay, directors and employers can ensure that contributions are correct and avoid costly mistakes. Directors should particularly note that they could be liable if a company has fraudulently evaded its NICs liabilities.
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Practical tip
Directors who are also shareholders often take dividends rather than salary. Dividends are not subject to NICs but, unlike salary, are not deductible in calculating the company’s corporation tax liability. Especially for family or one-person ‘close’ companies, comparative calculations of the corporate and personal liabilities arising for salary, dividends or a mix of the two will be essential.
