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What tax implications to expect when moving from employee to partner

Photographic portrait of Daniel Crouch
Daniel Crouch

Partner, US/UK Cross Border Tax Services, EY Private Client Services Limited

3 minute read 04 May 2021
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Tax
Tax planning
Private business
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Those promoted to the position of partner in the UK need to keep in mind the key tax and legal implications that come with it.

In brief
  • Promotion to partner within a firm usually means moving to self-employment for the first time.
  • No longer being an employee has significant consequences for what, when and how you pay tax.
  • In addition to tax status, National Insurance contributions are also affected.

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The move to Partner is not just a promotion. In a professional partnership, it is a transformation of the individual’s employment status. The move from being an employee to an ‘equity partner’ changes the way a person is taxed and how they pay tax. New partners need to make sure that they understand this transition.

In most cases, assuming special salaried member rules do not apply, when an individual becomes a partner, they will be treated as self-employed for tax purposes — which has significant consequences.
 

Moving to self-assessment/payments on account

As an employee, individuals pay income tax and National Insurance on earnings received from their employer. However, partners pay income tax and National Insurance on the taxable profits allocated from the partnership. It is important to note that the amount of profit allocated to a partner — and therefore subject to tax — can be different to the amount paid to them as a drawing from the partnership.

The income tax rates applied to partnership income are the same as those for employment income: progressive rates of 20%, 40% and 45%. However, partners who are treated as self-employed are required to file a UK tax return — unlike most employed individuals who, with certain exceptions, are not. Self-employed partners must register for self-assessment by completing a Form SA401, notifying Her Majesty’s Revenue and Customs (HMRC) that they are a partner.

Crucially, while employees have taxes deducted at source from their monthly pay through the Pay-As-You-Earn (PAYE) system, partners do not. Their allocation of partnership profit is typically paid out gross in the form of drawings and bonuses, with no taxes withheld. Instead, a partner is likely to fall within the system of payments on account, requiring them to pay tax twice a year:

  • 31 January (within the tax year)
  • 31 July (after the tax year ends)

Each payment on account is usually 50% of the previous tax-year’s tax bill.

Some partnerships operate a form of internal withholding from the partners, drawing to help partners with cash flow planning. The money is held in a tax account for the partners from which they can make the tax payments when they are due.

National Insurance contributions

Finally, it is not just the income tax arrangements that change with the move to Partner. National Insurance contributions (NIC) paid as a partner are also slightly different.

Employees are subject to Class 1 NIC contributions. In 2023–24, the rate for those earning more than £12,570 per year and up to £50,270 was 129% of the amount earned between those thresholds. Those earning more than £50,270 also pay 2% on all earnings over that amount. Employees’ contributions are deducted from wages by the employer.

Employers also need to pay Class 1 NIC, which for 2023-24 is calculated as 13.8% on earnings above £9,100 per annum.

Meanwhile, partners are subject to Class 2 and Class 4 NIC. The current rate for Class 2 NIC contributions is a flat £3.45 per week. Class 4 NIC contributions are paid as a percentage of the partner’s annual taxable profits — 9% of profits between £12,570 and £50,270, and a further 2% on profits over £50,270 (2022–23). They are paid on the same self-assessment schedule in January and July. The partnership does not have any obligation to make additional National Insurance payments.

Being aware of these requirements at the outset of promotion to Partner and seeking advice can help avoid problems when those dates come around.

Figures updated as of 23rd August, 2023. 

Summary

In a professional partnership, there is a substantial difference in the way partners and employees pay tax. For many promoted to partner, it will be their first experience of self-employment. Therefore, it is important to be aware of the change in tax status and requirements that such a promotion brings.

Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Neither Ernst & Young LLP nor EY Private Client Services Limited Ltd accepts responsibility for any loss arising from any action taken or not taken by anyone using this material. If you require any further information or explanations, or specific advice, please contact us and we will be happy to discuss matters further.

About this article

Photographic portrait of Daniel Crouch
Daniel Crouch
Partner, US/UK Cross Border Tax Services, EY Private Client Services Limited
Provides advice on private client tax issues. Specialises in topics related to individuals within partnerships in private equity and hedge funds. Loves to travel, and spend time with his wife and son.
Related topics
Tax
Tax planning
Private business
Workforce

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