If you scour the HMRC website of tax rates you won’t find a 60% Income Tax rate but this cliff edge rate exists. This gives us pretty much the highest tax rate in Europe. So much for us being a low tax economy!
How does the 60% rate come about?
The iniquitous 60% rate comes from the tapered loss of the Personal Allowance (currently worth £12,500). The Personal Allowance goes down by £1 for every £2 of income above the £100,000 limit. This means a marginal tax rate of 60% for those earning over £100,000. It is this intentional quirk in the system (introduced by Gordon Brown in 2010) that means the 45% ‘Additional Tax’ rate is not after all the highest rate of income tax.
Let’s look at Sally for instance. She lives in Cambridge and works as a software engineer. She has a total income of £100,000 in 2019/20. She has a Personal Allowance of £12,500 and pays Income Tax of £27,500. If though she had got her sought after pay rise to give her a total income of £125,000, she would lose all of her Personal Allowance and would pay tax of £42,500. This is further tax of £15,000 on her increased income of £25,000 which is a tax rate of 60%. (See table below for the full calculation).
Those at particular risk can be employees who receive variable (and therefore of prior uncertain value) bonuses which are paid toward the end of the tax year. These may push their total annual income above £100,000. People with fluctuating profits are also at risk. A resultant 60%tax rate is clearly an unwelcome result.
So where does your 62% headline rate come from?
In addition to Income Tax, additional National Insurance is also charged to higher earners at 2% of earnings (another initiative of Mr Brown). The combined 60% Income Tax rate and 2% National Insurance rate gives an eye watering 62%. Many people turn down promotion or more work to avoid such high rates of tax which can only be detrimental to the tax take for the Treasury and ultimately the economy.
So can anything be done about it?
Yes quite a lot.
Two particular tax efficient strategy opportunities are:
- Pension contributions. These are allowable for tax relief (up to £40,000 a year) (subject to further restrictions if income exceeds £150,000). This effectively takes the pension contribution out of tax.
- Charitable donations under Gift Aid. These are treated in a comparable way to pension contributions
Salary sacrifice can also offer ways to reduce taxable income and these can have additional National Insurance benefits.
Depending on someone’s specific circumstances a number of other legitimate tax planning opportunities exist. Owner manager business owners have even further lawful options to mitigate tax if they structure their business in the right way.
It is estimated that over one million taxpayers in the UK earn over £100,000 with a quarter having an income in the £100,000 to £125,000 band. If you are in this positon do get in touch for further information and to see how we might help you avoid this cliff edge 60% tax rate.
This is a general article on the position in England. Under devolution Scotland has slightly different tax rates. Wales could have different rates but has chosen not to do so in 2019/20. The article neither constitutes investment nor financial advice. Before taking specific action it is recommended that suitable advice is taken from a qualified professional.
David Eaton