Contractor Doctor: How do I work out my NICs when I leave my job to be a contractor?

Dear Contractor Doctor,

I have just started contracting in an interim role using my own contractor limited company. Before that, as an employee I earned £22,000 in this tax year, on which I paid income tax and National Insurance Contributions (NICs) under PAYE.

What is the best way for me to pay myself now I’ve started as a contractor and make sure I stay up-to-date with my National Insurance ‘stamp’ payments?



Contractor Doctor says:

According to Phil Richards of BFCA Chartered Accountants, if a contractor has earned over £5,720 from other work, such as through previous employment, then there is no need for the contractor to pay himself or herself any further salary from a National Insurance Contributions (NIC) perspective in that tax year.

“Contractor NICs are cumulative, but not pro rata in a given tax year,” explains Richards. “So, from a tax perspective, once a contractor has earned more than their personal allowance amount of £6,475, then there is little point in the contractor paying themselves any more salary – they have already earned up to their tax-free limit.”

NICs are cumulative

The contractor will have paid tax on their earnings if the £6,475 was in the form of salary, with their income tax and NICs deducted at source by PAYE. And if their employment period was less than 12 months, the contractor could well get a tax rebate on completion of their tax return.

Richards says that, although NICs are cumulative, they are not pro rata over the year: “A contractor limited company director will pay NICs when they go over the threshold in that ‘employment’ as a director in one tax year. That could be in one month or 12 months of ‘employment’. A contractor could, for example, pay themselves nothing during the financial year until March and then pay themselves £5720 and still not pay NICs.”

Payment by dividend, not salary

Contractors who have worked for a couple of months in the tax year as employees on a decent salary and then make the switch to becoming a limited company contractor are likely to have earned over the their tax-free allowance and paid sufficient NICs to ensure they qualify for all the benefits entitlements.

Richards continues: “In a case like this contractor’s, having earned £22,000 this tax year as an employee and now working through their own limited company, the contractor would be wise to pay themselves a dividend rather than a salary; otherwise, they will end up paying unnecessary income tax and NICs.”

He does add that, although directors don’t have to pay themselves the minimum wage, there may be reasons, such as for pension requirements or in respect of any benefits claimed, that could require a contractor to continue salary payments. Contractors should check with their contractor accountant to ensure that there is no reasons for them to be paid a salary, rather than just dividends.

We advise our clients that they should pay some, but not too many, NICs during a financial year so that they qualify for the full range of state benefits available

Phil Richards, BFCA

NIC payments to maintain benefits

There are no hard and fast rules about what NIC payments a contractor should pay during each tax year, as these will depend on individual circumstances, the contractor’s gender and a number of other factors.

“We advise our clients that they should pay some, but not too many, NICs during a financial year so that they qualify for the full range of state benefits available.”

Good luck with your contracting!

Contractor Doctor

Published: Wednesday, October 21, 2009

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