UNDERSTAND PERSONAL TAX AND NI FOR SELF EMPLOYED

UNDERSTAND PERSONAL TAX AND NI FOR SELF EMPLOYED

A practical breakdown on personal tax and national insurance (NI). For employees and self employed.

CONTENT

  1. PERSONAL TAX
    Tax Brackets for Income Tax
  2. NATIONAL INSURANCE TAX (NI)
    NI for Self Employed Individuals
  3. PRACTICAL EXAMPLES
  4. TAX EXAMPLE FOR SELF EMPLOYED
  5. RESOURCES

PERSONAL TAX

When we talk about taxes, most people immediately think of income tax, maybe the tax bracket they are in and so forth. However, both personal tax and National Insurance (NI) are both a form of direct tax. And both should be considered when trying to work out your net earnings after taxes.

Glossary: direct tax

A tax on a person’s income. This is not a tax on goods and services, rather it is based on the earnings of an individual.

Income tax can be flat rate – in Eastern Europe, predominantly, tax is worked out as a fixed percentage regardless of your level of income. However, UK system is a bit different as the intention of the government set rates is to reduce social inequality and encourage social mobility.

This does lead to a more complicated tax system – which makes it hard for an individual to work out their own tax liability without at least some basic training.

The UK offers a Personal Allowance (PA), meaning that, for the value of that PA for the respective tax year, there is no tax incurred.

For the tax year starting 6 April 2020 and ending 5 April 2021, this PA is £12,500. This tax-free amount is there to help people in low-income brackets and reduces even up to Nil in the case of high earners who find themselves in the Additional Rate band – the highest tax bracket in the UK.

The tax brackets for income tax are as follows:

Tax Rate BandIncome LevelTax %
Personal Allowance£12,5000
Basic Rate£12,501 – £50,00020%
Higher rate£50,001 – £150,00040%
Additional Rate£150,001 +45%

Apart from tax on earned income, there is also a tax for dividend income, interest on savings, certain benefits either from employment or state benefits.

The first £5,000 from savings is not taxable if your income is not higher than £17,500. If you earn more than £17,500 per year (that is, your PA of £12,500 plus the £5,000 starter rate for savings) then you will lose this option, but you could claim the first £1,000 of savings as a tax-free allowance.

In the UK there are also additional allowances which can reduce a tax payer’s bill. The most common ones are the marriage allowance and, more recently introduced, the first £1,000 of self-employed or rental income earned.

This more recent allowance has been created mainly for those who are in normal employment and receive a traditional salary but have the occasional “side income” and aims to simplify one’s tax bill if this side income is below £1,000 a year.

You can sign up and set up your personal tax as well as check your records and details on the Governments HMRC website

NATIONAL INSURANCE TAX (NI)

If you are an employee and get paid through PAYE, National Insurance tax is calculated and collected automatically through your payslip. This is also called Class 1 NI.

NI for Self Employed Individuals

There are 2 types of National Insurance if you are self employed.

  • Class 2 if your profits are £6,475 or more a year
  • Class 4 if your profits are £9,501 or more a year

Class 2 and 4 NI if earnings exceed the thresholds, learn more on Self-employed National Insurance rates.

National Insurance Class 2 and 4 for self-employed
SELF-EMPLOYED CLASS 2 AND CLASS 4 NATIONAL INSURANCE (NI)

In a similar fashion to the personal allowance, NI is also only paid for earnings above a certain threshold as described below.

NI ClassThreshold pa.Amount payable 
Class 19,504 50,00412% 2% 
Class 26,4753.05 per week 
Class 49,501 50,0019% 2% 

As opposed to income tax which is a progressive tax, NI is a regressive tax, meaning that the tax reduces as the income increases. For income tax, as we’ve seen earlier, as the person earns more they are moving up through the tax brackets and also losing their allowances.

Glossary: Regressive Tax

A tax which normally benefits people in the higher strata of society as it taxes the poorer at higher levels than the richer.

National Insurance tax is used to fund the NHS and also the state pension. Once a person reaches retirement age, they no longer need to make this contribution.

PRACTICAL EXAMPLES

John Doe earns a salary of £12,000 pa. at his part time job. He has a high interest savings account where he earns £7,000 pa. What is his tax bill?

Type of incomeBandTax
Salary 12,000<PA of £12,5000
Savings 500<PA of £12,5000
Savings 5,000Interest on savings starter rate0
Savings 1,50020%300
IncomeNational InsuranceTax
Salary 12,000First 9,504Nil
 9,504-12,000 @ 12%Circa 300

John will pay a total of 600 pounds per year for his tax bill, making his effective tax rate 3.15% (600/19,000)

Glossary: effective tax rate

Represents the average tax rate an individual has to pay once all direct taxes have been factored in and includes all types of income earned.

Amy Beerhouse earns a salary of 157,000 and also rents out a room for 12,000 pa. As she earns over 125,000 per annum from her job, Amy loses all the personal allowance of 12,500 for the year. What is Amy’s tax bill?

Type of incomeBandTax
Salary 157,00050,000 @ 20%10,000
 50,001 – 150,000 @ 40%40,000
 150,001 – 157,000 @ 45%3,150
Rental income of 12,000 pa7,500 Lodger’s Allowance 7,500-12,000 @ 45%0 2,025
IncomeNational InsuranceTax
Total income 169,000First 9,504Nil
 9,504-50,004 @ 12% 50,004-169,000 @ 2%4,860 2,380

TAX EXAMPLE FOR SELF EMPLOYED

Amy will pay a total of 62,415, making her an effective tax rate of 37% (62,415/169,000)

Harry Smiles earns a salary of 37,000 and also works as a DJ on weekends, earning circa 5,000 per annum. What is Harry’s tax bill?

Type of incomeBandTax
Salary 37,00012,500 Personal Allowance0
 12,500-37,000 @ 20%4,900
Self employed income 5,000First 1,000 under allowance0
 1,000-5,000 @ 20%800
IncomeNational InsuranceTax
Total income 42,000First 9,504Nil
 9,504-42,000 @ 12%3,900

Harry will pay a total of 9,600, making his effective tax rate of 22.9% (9,600/42,000).

RESOURCES:

This is a list of information from the GOV.UK website
https://www.gov.uk/topic/personal-tax/national-insurance

Calculate VAT the full guide
https://www.startinbusiness.co.uk/business-tax/vat-value-added-tax-calculation-the-full-guide/

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