People who are self-employed, between age 16 and the state retirement age, and earning over a certain amount, are required to pay National Insurance Contributions (NICs) in the UK. Someone who starts being self-empoyed must register with HMRC within three months of starting work; otherwise they risk paying a fine.
There are two kinds of NICs for self-employed people, called Class 2 NICs and Class 4 NICs. Those earning more than around 6,000 pounds in a tax year will have to pay both kinds of contributions. Class 2 NICs consist of a relatively low, flat rate, while Class 4 NICs depend on the level of your income.
Class 2 NICs must be paid by those earning more that 5,075 pounds in the tax year 2010-2011, or 5,315 pounds in the tax year 2011-2012. Earnings, here, means net profit (that is, income less expenses) as shown in your financial accounts, as earned over the course of the tax year. Class 2 NICs are a flat rate of 2.40 pounds per week (2.50 from April 2011) – around 12 pounds per month or 150 pounds per year.
Class 4 NICs are worked out as follows. If you are earning between 5,715 and 43,875 pounds in 2010-11, you will have to pay 8% of your earnings above 5715. For example if your earnings are 6715 pounds, you will have to pay 8% of 1000 pounds, or 80 pounds for the year. On the other hand, if you earn 40,715 in the tax year, you will have to pay 8% of 34,000, or 2,720 pounds in the year. These rates will change for the tax year 2011-12. The range will change to between 7,225 pounds and 42,475 pounds, and the rate will increase to 9%.
Furthermore, for any amount you earn over the upper limit – 43,875 in 2010-11 and 42,475 in 2011-12 – you will have to pay 1% (2010-11) or 2% (2011-12) as Class 4 NICs. For example, if you earn 44,875 in 2010-11, you will have to pay 1% of 1000, or 10 pounds for the year, in addition to 8% of the difference between 44,875 and 5,715.
For the purposes of working out class 4 contributions, your ‘earnings’ means your taxable trading profits, rather than the net profits shown in your accounts. The main difference between these two is that certain things will be tax-deductible for the sake of calculating taxable trading profits. In particular you can deduct income not gained through basic trading activities, as well as certain allowances for capital expenditure, when calculating your earnings. However, you will also have to add back onto your net profit any expenditure that is not directly related to your main business activities.