The recent focus of successive Chancellors has been to increase the personal allowance, removing more people from the tax paying arena and increasing the take home pay of others.
However, for those with adjusted income in excess of £100,000, the personal allowance is gradually withdrawn, resulting in an effective tax rate of 60%. This is a good 15% higher than the supposed top rate of income tax of 45% and comes as a surprise to those caught out by its effects.
So how does this 60% tax rate come about? For the current tax year the personal allowance is £11,500. Where an individual has adjusted net income over £100,000 the personal allowance is reduced by £1 for every £2 of the excess. This produces an effective rate of 60% on income within that range. The personal allowance is withdrawn fully where adjusted income is in excess of £123,000 and in fact, those in employment and the self-employed will be suffering a total charge of 62% when national insurance is taken into account, leaving them with only 38p of every pound earned.
So is there anything can be done to mitigate its effect? Well adjusted net income is all taxable income, less certain allowances. So here are a few ideas that are worth thinking about.
Firstly, have you joined the club because of a one-off event such as a large bonus or dividend? Where it is within your control, consider altering the contractual entitlement to the payment to smooth income between tax years.
Another way of reducing taxable income applies if you are married or in a civil partnership. You can normally transfer income producing assets to your spouse without a tax charge. The income arising then becomes their income not yours. This only works of course if they are not themselves a member of the club!
If you are a permanent member of the club, think about replacing taxable income with non-taxable income. This could be as simple as holding investments through an ISA as opposed to directly or more complex salary sacrifice arrangements replacing cash salary with tax free or tax favoured benefits in kind. Although changes to the tax rules from 6 April 2017 severely curtailed the types of benefits qualifying for tax favoured treatment via salary sacrifice, it is still worth considering bearing in mind the tax saving is potentially 62%.
One particularly effective use of salary sacrifice is to replace salary with pension contributions. A salary reduction of £10,000 in favour of a pension contribution for someone within the club would have a net cost of only £3,800. A significant saving. Even if salary sacrifice is not available, a direct pension contribution is just as effective as it is one of the allowances deductible to arrive at adjusted net income.
Similar to pension contributions, charitable gifts under gift aid qualify as an allowable deduction to arrive at adjusted net income. A gift aid payment of £800 would reduce the tax bill of a club member, making the net cost only £400.
The Institute of Fiscal Studies estimate that 800,000 people will pay the 60% tax rate in 2017/18 and this will rise to an estimated 1,000,000 people in 2018/19. Don’t drift inadvertently into a club that Groucho wouldn’t have wanted to join. A little planning could go a long way in reducing the impact.
For more information on taxable income or tax planning, please contact Stuart McKinnon on 0191 255 7000, stuart.mckinnon@rsmuk.com or your usual RSM contact.
