Special rules apply for directors for class 1 national insurance contributions (NIC). All directors, regardless of their actual pay interval, have an annual earnings period. This means that the class 1 contributions for the year are calculated by reference to the annual NIC thresholds, rather than by reference to those for the pay interval.

A ‘director’ is as defined in reg. 1 of the *Social Security (Contributions) Regulations 2001 *(SI 2001/1004).

**Making deductions**

There are two methods that can be used to work out a director’s class 1 NIC: the annual earnings period basis and the alternative basis. The end result is the same: the director and employer will pay the same amount of NIC regardless of the method used, but the pattern of deductions will differ.

**Method 1: Annual earnings basis**

Under this method, national insurance contributions are calculated on a cumulative basis by reference to the annual rates and threshold. Thus, no employee contributions are due until the primary threshold is reached, contributions are then payable at 12% until the upper earnings limit is reached. Thereafter contributions are payable at 2%.

For employer contributions, no contributions are payable until the secondary threshold (or upper secondary threshold for under 21s, or AUST, where relevant) is reached. Thereafter contributions are payable at 13.8%.

The contributions to be deducted from each payment are found as follows:

*Step 1*

Work out the contributions due on the earnings to date using the annual thresholds.

*Step 2*

Deduct contributions paid so far in the tax year. The balance is the contributions due on the current payment.

**Example 1**

Mark is a company director. He is paid £6,000 a month. His earnings are worked out using the annual earnings period basis.

The primary and secondary thresholds for 2019/20 are set at £8,632 and the upper earnings limit is set at £50,000.

Mark pays no contributions in month 1 as his earnings are below the primary threshold.

In month 2, his total earnings for the year to date are £12,000. Using the annual earnings thresholds, contributions due on £12,000 are £404.16 (12% (£12,000 – £8,632)). As he has paid no contributions yet in the tax year, his employer must deduct contributions of £404.16 from the month 2 payment of £6,000. Employer contributions are calculated in a similar way and for month 2 are £464.78 (13.8% (£12,000 – £8,632).

For months 3 to 8 inclusive, contributions are deducted at the rate of 12% (£720) as cumulative earnings fall between the primary threshold and the upper earnings limit.

In month 9, year-to-date earnings are £54,000, on which contributions of £5,044.16 are due ((12% (£50,000 – £8,632) + (2% (£54,000 – £50,000)). Up to and including month 8, contributions of £4,724.16 have been paid (12% (£48,000 – £8,632)). Therefore contributions of £320 (£5,044.16 – £4,724.16) are due in month 9. This is equivalent to (£2,000 @ 12%) + (£4,000 @ 2%)). In months 10, 11 and 12, the director pays contributions at the rate of 2% as the upper earnings limit has been reached – equal to £120 each month.

Employer contributions in months 3 to 12 are £828 (£6,000 @ 13.8%). As the secondary threshold has been reached, all earnings are liable at the rate of 13.8%.

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**Method 2: Alternative basis**

One of the effects of using the annual rates and thresholds is that deductions can vary considerably, even though gross salary payments are constant.

To allow contributions to be deducted more evenly throughout the year, the director can elect to use the alternative arrangements. These allow the director’s NIC to be calculated by reference to the thresholds for the pay interval, as for other employees.

A recalculation is performed at the time of the last payment using the annual thresholds, and any contributions still owing are deducted from the final payment. If the final payment is insufficient to cover the primary contributions due, these must be paid by the employer.

**Example 2**

The facts are as in example 1, except that Mark opts for the alternative arrangements. The class 1 NIC is calculated by reference to the monthly thresholds, ie the primary and secondary threshold of £719 and the upper earnings limit of £4,167.

In each of month 1 to 11, Mark pays NIC of £450.42 ((12% (£4,167 – £719) + (2% (£6,000 – £4,167)). Employer contributions are £728.78 (13.8% (£6,000 – £719)).

In month 12, an annual recalculation is performed. On earnings of £72,000, primary contributions of £5,404.16 ((12% (£50,000 – £8,632) + (2% (72,000 – £50,000)) are due. Mark has paid £4,955.72 (11 x £450.52) so far. Contributions of £448.44 are therefore deducted in month 12.

Likewise, employer contributions for the year are: £8,744.78 (13.8% (£72,000 – £8,632)), of which £8,016.58 (11 x £728.78) has been paid, leaving £728.20 to pay in month 12.

Remember to setup your payroll software correctly for the method (1 or 2) that has been chosen.