How to claim employment allowance

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* Please note that some of this article has now been updated to reflect forthcoming changes due in April 2025 as a result of the Chancellor’s Budget Announcement held on 30th October 2024. It will be updated in full come April 2025.

When it comes to considering whether you’re ready to hire your first employee(s) for your business, it’s certainly not a quick decision that can be easily made. In the UK, it’s estimated that only 1.5 million private businesses hire at least one employee compared to the 4.1 million private businesses that choose to operate on a solo owner basis. Often, the biggest factor to account for is whether you can afford to pay the employee. The cost of hiring an employee far extends past simply their salary but also includes a range of other financial obligations such as pension contributions, statutory pay, and national insurance. This is where learning how to claim employment allowance will help.

What is employment allowance?

The employment allowance was first introduced by the UK government in 2014. It is a tax relief scheme that aims to support small businesses. It encourages employers to expand their business by hiring employees, and in return reduces the burden of Employer’s Class 1 National Insurance (NI) contributions. By claiming employment allowance, eligible employers can worry less because Employer’s Class 1 NI will be partly subsidised.  

As an employer, not only is it your responsibility to collect ‘Primary’ Class 1 NI contributions from your employees’ earnings, but you are also required to pay ‘Secondary’ Class 1 NI for every employee you hire that is paid over £175 a week. Claiming employment allowance goes towards paying for secondary Class 1 NI.

How much is employment allowance?

Since April 2022 the employment allowance has increased from £4,000 to the maximum of up to £5,000. It is due to increase to £10,500 come April 2025. For those who do not require the full amount, you will still be able to claim employment allowance to cover any Employer’s NI up to the maximum amount. 

How to qualify for employment allowance

In order to qualify for employment allowance, you firstly need to be a registered employer. You can employ staff regardless of whether you operate your business as a sole trader, partnership or limited company but you must register with HMRC and obtain a PAYE reference number.

If you are running your business as a limited company, then you can claim employment allowance so long as you have a minimum of one employee who is earning above the NI threshold or there are a minimum of two directors earning above the NI threshold even though there are no employees working at the company.

Currently, your business must be considered small enough to be eligible for employment allowance. This is measured by your Employer’s Class 1 NI liability which must be less than £100,000 in the previous tax year. If you are a new business taking on employees for the first time, it is unlikely that you will reach this limit. However, from April 2025 this threshold will be removed so that any size business can claim employment allowance.

Who cannot use employment allowance

Despite meeting the above conditions, your business may still be ineligible to claim employment allowance in certain circumstances. This can include where over half your business is involved in working for or in public sectors such as local councils or the NHS. Work such as providing cleaning services, security services or IT services would not count towards this rule, however business activities such as debt collection or refuse collection would.

If you employ freelancers or contractors as part of your business, and you have no other employees or a second director in the company, then you will not be eligible to claim employment allowance because they are not paid via the PAYE system. Freelancers and contractors are usually paid when they issue you with an invoice for their services supplied and so you would have no NI to pay. However, if the freelancer or contractor falls within the scope of IR35 then they would be classed as an employee and should be added onto your payroll. In this instance, you could then claim employment allowance.

Where you employ someone to carry out personal, household, or domestic work for you, this would not qualify your business as eligible to claim employment allowance, because the work performed is for you personally. Examples of these types of work can include personal trainers, nannies, or domestic cleaners. The one exception to this rule is if you hire carers or support workers.

How does employment allowance work?

Claiming employment allowance entitles you to receive up to a £5,000 reduction from your Employer’s Class 1 NI liability. As an employer, you are charged a specific rate depending on your employee’s NI category letter. The NI category letter defines any special treatment regarding NI that your employee may have, such as whether they are entitled to pay reduced NI rates or no NI at all. Most commonly however, employers will be charged a rate of 13.8% on employees’ earnings where they are earning above the primary threshold limit. Any benefits-in-kind offered to your employees which are taxable will also attract NI, but they are classified as Class 1A and Class 1B. The employment allowance cannot be used to reduce this type of NI liability.

The employment allowance is applicable to your business as a whole, not to each individual employee that you may have. So, unlike the staff entertainment allowance, which is £150 per head, the £5,000 limit is applicable to your entire payroll. If you are a director of multiple companies, then be aware that you’ll only be able to use the employment allowance against one of them. The employment allowance is also not given all in one go but works by deducting your Employer’s Class 1 NI liability at each pay period. It means that your liability is deducted each month until the £5,000 limit is exhausted.

For example, you hire your first employee who receives an annual wage of £24,000 per year. You are required to pay 13.8% in Employer’s Class 1 NI which equates to £171.35 per month. You are paying yourself a tax-efficient director’s salary of £12,570 per year. It means you will also need to pay 13.8% on this because your salary is over the primary threshold. This amounts to £39.91 per month. Together, the combined monthly total of Employer’s NI is £211.26. There will be no Employer’s NI for you to pay for the entire year because the total annual NI liability comes to £2,535.06 which falls under the employment allowance limit.

As a secondary example, you hire an employee who receives an annual wage of £42,000. This would attract £378.35 in Employer’s NI each month. You are still paying yourself a director’s salary of £12,570 so still have £39.91 to pay each month. Your total monthly Employer’s NI liability is £418.26. You will have no Employer’s NI to pay for 11 months but will be required to pay £19.06 in Employer’s in the 12th month as your total annual NI liability amounts to £5,019.06 which goes over the employment allowance.

How to claim employment allowance

How you can go about claiming employment allowance will be dependent on the payroll software you are using. If you are using your own software, then there will be a tick box for you to select ‘yes’ for employment allowance. You should select this the next time you send an Employment Payment Summary to HMRC. This will then automatically calculate and deduct your Employer’s NI until you exceed the employment allowance and are required to pay. 

Where your payroll software does not have an Employment Payment Summary field, you can use HMRC’s Basic PAYE Tool instead to claim employment allowance. This is free software suitable for businesses with no more than 10 employees. You will need to download it but must be registered as an employer with HMRC before being able to do this.

When to claim employment allowance

There is no fixed time or deadline when you should claim employment allowance. However, it is recommended that you do so as soon as you become eligible as it’ll mean your Employer’s NI liability will be reduced sooner rather than later. It is important to take note that you must make a claim each year that you are eligible by submitting an Employment Payment Summary to HMRC otherwise you’ll become liable for the full Employer’s NI payment.

If you find that halfway through a tax year, you become no longer eligible to claim employment allowance, you can continue claiming for the rest of the year but will need to update your Employment Payment Summary the following new tax year.

What to do if you’ve missed out claiming employment allowance

If you’ve only just realised that you could be claiming employment allowance but have been paying your Employer’s NI, then, at the end of the tax year you can either request a refund to receive cash back, or leave it on your PAYE account to offset against the next year’s Employer’s NI liability.

You are also able to retrospectively claim for previous tax years, but only for up to the past four tax years that you were eligible to make a claim. To do this, you will need to submit a separate Employment Payment Summary for each of the previous years.

Did you know that claiming employment allowance counts as de minimis state aid?

If your company sells goods or services, then claiming employment allowance will count as de minimis state aid. You will need to declare this as part of claiming employment allowance either through your payroll software or the HMRC Basic PAYE Tool. It is important to be aware of this because there is a legal limit to how much each company can receive in state aid, so this may affect you if you claim employment allowance as well as receive other forms of state aid. For most industries, the maximum you can receive in state aid over a three-year period is €200,000 but for some other industries it is less. This limit applies regardless of whether your company is making a profit or not. Furthermore, it is particularly important to keep an eye on your state aid limit if your company claims R&D tax credits.

Get help with claiming employment allowance

If you’re finding running your payroll correctly a tricky business, or are having difficulty claiming employment allowance, then why not reach out to find out more about our payroll services? We’ll be able to give you tailored advice to your business regarding the different limits as well as your own director’s salary. Get a consultation call today by completing the online form to arrange it.