How will the National Insurance and Dividends tax rise impact you?

All eyes were on Prime minister Boris Johnson on the 7th September as he set out the government’s plans for a pledge breaking tax rise.

The increase in National Insurance and Dividends Taxes means that no matter if you are an employee, self-employed, or a limited company owner-manager you will be facing an increased tax bill next tax year. This is on top of the freeze in the personal allowance and income tax bands which means when adding on inflation in the economy there is a significant increase in tax in “real terms”.

National insurance for the self-employed

This is on top of the rates payable for income tax (0%, 20%, 40% or 45% depending on level of income) and the flat rate of Class 2 National Insurance paid when profits exceed £6,515, which is an additional tax worth c.£158.60 per year.

National insurance for employees and employers

Employers will pay an increased level of National Insurance on all wages over the “Secondary Threshold” (expected to be c. £760 per month*) at a tax rate of 15.05%.

*We are awaiting confirmation by HMRC for the National Insurance bandings as these are expected to be increased by September’s Consumer Price Index. The “Upper Earnings” and “Upper Profits” limits have however been confirmed to not be changing from the 2021-22 levels.

Dividends taxes

The increase in taxes – labelled as the “health and social care levy” – also increased taxes payable on dividends.

After utilising any personal allowance and assuming no other income affecting your tax bands the tax rates for dividends recognised in the 2022-23 tax year are as follows:

** Note that when total earnings exceed £100,000 the personal allowance is reduced by £1 for every £2 of earnings over this threshold until there is no personal allowance remaining.

While we are yet to have the rates confirmed to provide our recommended salary and dividends levels for owner-managed limited companies, we expect the annual personal tax liability for someone earning £50,270 via salary and dividends to be c. £3,124 payable personally on a tax return. This is after having to pay a minimum of £9,652 of Corporation Tax to secure the profits needed to vote these dividends.

A single owner/director company with no employees would therefore be paying a total of £12,776 in taxes to secure the full basic rate of income. A sole trader earning the same amount would pay £11,840 in taxes.

On the face of it, this suggests that operating as an unincorporated business is more tax-efficient in terms of basic rate income. However, it is important to note that limited companies have the advantage of incurring a lower rate of tax on earnings that are retained within the company, whereas unincorporated businesses always pay the highest rate of tax on any profits not drawn in the year. Ultimately a limited company provides a better vehicle for controlling how much personal income you recognise. It certainly is a more complicated decision than it used to be!

Over the coming year, this will be one of the most important areas of review. If you want to know what the best tax structure is then you will need to be able to forecast the following:

1. How much you need to draw from your business for lifestyle costs
2. How much additional draw you need as a “bonus” each year
3. How much profit and cash you expect your business to generate in a year
4. Your investment plans
5. Your plans for an eventual exit from the business

All these factors have a significant impact on deciding the best trading structure. Tax is very important but knowing your longer-term plans may suggest saving Income Tax today isn’t the biggest tax saving you could be making overall.

If you want to review this in more detail, then please speak to your Principal Adviser and book a review meeting.