Making the most of the employment allowance

Introduction

Unsurprisingly, payroll costs have blown many 2025 budgets due to statutory obligations affecting wage rates and secondary Class 1 NI, which is payable by employers on the earnings of employees. Focusing on NI alone, the April 2025 changes inflicted the double hit of an increased secondary Class 1 rate of 15% coupled with a reduction to the level of earnings at which it usually starts being paid; now a paltry £5,000 per annum (£96 per week; £417 per month).

The April 2025 rises in the National Minimum Wage (NMW), including an 18% rise for youngsters (aged 16-17), have also exacerbated the difficulties of maintaining differentials between grades.

A much higher secondary threshold of £50,270 per annum applies to a small cohort of employees, including those under the age of 21, apprentices under 25 and veterans who have left the armed forces within the last twelve months. For employees within the first three years of their employment at a recognised freeport or investment zone, only earnings over £25,000 per annum are liable to secondary Class 1 NI.

Solution

First introduced in 2014, the employment allowance (EA), quietly offsets secondary Class 1 NI until the 2025/26 threshold of £10,500 is used up. This has reduced the impact of the NI changes for employers, materially so for the smallest, assuming of course they are eligible and a claim is made.

A claim made part way through a tax year still entitles the employer to a full EA which will cancel out secondary Class 1 NI already paid.

Who can claim?

For 2025/26, the previous £100,000 limit on the prior year’s Class 1 bill was abolished and the EA is no longer treated as de minimis State Aid, enabling all employers to access the EA other than those who are:

• one-person companies where the director is the sole employee or all other employees earn below the secondary threshold
• deemed employers under the off-payrolling rules
• public bodies
• domestic employers paying for personal or household work, i.e. a nanny or gardener, but not care workers
• businesses (not charities) undertaking more than 50% of their work in the public sector, with the exception of those providing IT, security or cleaning services.

If the business becomes ineligible for the EA, any existing claim for that tax year is generally undisturbed. The EA is ringfenced to a particular business and particular tax year. It can’t be transferred on a business sale.

One-person companies

Whichever method of profit extraction is used, a small salary is likely to feature in order to ensure the tax year qualifies for the purposes of the state pension. As this requires a minimum salary of £6,500 p.a., secondary Class 1 NI will be payable.

To access the full amount of the EA for the entire tax year, a one-person company could temporarily take on another employee (such as a family member) who is paid more than the secondary threshold for just a single pay period.

Example. Vanessa is the sole employee and director of her company, earning £2,000 per month in 2025/26, incurring secondary Class 1 NI of £237 ((£2,000 - £417) @ 15%). After taking account of corporation tax at 19%, the after-tax cost of all 2025/26 payroll costs is £21,744 ((£2,237 x 12) x (100% - 19%).

If Vanessa employs a student to do some filing in January (Month 10), paying £130 for the week, this gives access to the EA which will offset the nine months of secondary Class 1 NI already paid of £2,133. The total 2025/26 payroll costs are now £24,130, or £19,545 after CT, saving £2,199 (£21,744 - £19,545).

How many EAs?

Each business receives just one EA per tax year. If running multiple PAYE schemes, employers must initially nominate the one where they believe most of the EA will be used. Any surplus EA can either generate a refund, assuming all PAYE is up to date, or set against a forthcoming PAYE debt.

An employer operating two PAYE schemes, one weekly and one monthly, can apply a single EA to both schemes.

Example. Car for You Ltd, a car dealer and garage, runs two payrolls to reflect each of its departments. It nominates the car showroom payroll for the EA. The total secondary Class 1 NI bill is only £9,000, while the garage’s NI bill is £6,000. The company can apply to HMRC to set the unused EA of £1,500 against the garage’s bill (£10,500 – £9,000).

However, an employer is prohibited from making its own claim where a connected company or charity has already used the EA for that tax year. Once connected, employers remain so for the whole tax year although new joiners or newly incorporated subsidiaries won’t be connected to the group until the start of the next tax year.

Any unused EA cannot be transferred to other group members.

How to claim

An EA claim is made on the employer payment summary (EPS) for each tax year. Most payroll software will ask the question for the first payroll period as a claim made in a prior tax year does not automatically roll over. The EA is given in full in every earnings period until the threshold of £10,500 is used up, or the end of the tax year arrives. The consequence is inevitably frontloaded which can result in a sudden spike in the NI bill in the latter months of the tax year.

Pro advice. Employers whose average monthly PAYE is below £1,500 can phone the Employer’s Helpline to pay their PAYE/NI quarterly (i.e. NI payable for January to March will be delayed until 22 April). However, those already paying quarterly will need to convert to monthly payments in the latter months if this threshold is exceeded.

Example. Marco is a restaurateur, employing twelve part-time workers at NMW. The employers’ NI is £1,500 per month which the EA cancels out, but only until October. From November 2025 onwards, the monthly PAYE/NI bill will increase by £1,500 directly affecting his bottom line and jeopardising his fragile cash flow.

Practical action

Although at the beginning of 2025/26, £10,500 might have seemed to be sufficient to cover the bumper secondary Class 1 NI bill, the crunch could come towards the latter months of the tax year. Employers should be aware if, and when, their EA will run out, so planning is possible.

Delay pay increases. To avoid aggravating the situation, delay paying bonuses and implementing pay rises until after 5 April 2026. Future remuneration packages could include exempt benefits or the payment of employer pension contributions in lieu of extra salary as these escape NI.

NMW rises, although effective from 1 April, do not have to be implemented until the pay period which starts after 1 April.

Cash flow injection. Claims, using an EPS, can also be made in respect of the past four years (so 2021/22’s deadline is 5 April 2026), with the caveats that the £100,000 limit of Class 1 NI applied and a reduced EA threshold of £5,000 (£4,000 for 2021/22) was in force. HMRC will refund the business on request along with interest repayment supplement.