Don’t lose your tax-free allowance

If you earn over £100,000, you could lose your tax-free allowance.

This could lead to an unexpected tax bill if your earnings for a tax year are higher than expected (for example from a pay rise or a bonus) and your tax code was set by HMRC to include a personal allowance.

Loss of the personal tax-free allowance

The basic personal allowance for 2015/16 is £10,600. However, this is reduced by £1 for every £2 by which your income exceeds £100,000. The measure of income for these purposes is “adjusted net income”.

This means that, if you have adjusted net income of £121,200 or above, you will lose your whole personal allowance for the year.

Keep out of the danger zone

The danger zone for tax is when your income is between £100,000 and £121,200. The effective rate in this zone is a massive 60%. This is the normal 40% tax rate plus the impact of losing your tax-free allowance.

The maths

The slice of income between £121,200 (the level at which the personal allowance is fully lost) and £100,000 (the level above which abatement starts) is £21,200. Tax at 40% on this band is £8,480 (£21,200 @ 40%).

The personal allowance is £10,600. Losing the allowance means you pays tax on a further £10,600 @ 40% = £4,240.

The total tax hit on this slice of income is £12,720 (£8,480 plus £4,240), which is a whopping 60% of £21,200. Therefore, the effective marginal rate of tax in the abatement zone is 60%.

4 tips to stay out of the danger zone

Reducing your income to below £100,000 will mean your personal allowance isn’t lost and the massive 60% effective tax rate is avoided. Here are 4 tips to do this:

  • Transfer income-producing assets to your spouse/civil partner – for example, if you have dividend or savings income, you could transfer the shares/savings to a your spouse if they earn less.
  • Delay dividend payments – if you’re a business owner, you could delay your dividend income to the next tax year, ie after 5 April 2016. This can be beneficial if it helps keep income in the current year below the abatement zone. You can do the same for bonus payments. [However, do keep an eye on the dividend tax changes from April 2016.]
  • Make pension payments – adjusted net income can be reduced by making pension contributions, which is in itself beneficial due to the higher rate relief available on contributions up to the available annual allowance.
  • Charitable donations – making charitable donations will also reduce adjusted net income (although you do lose the benefit of that income).

Tax code shock

If you think your income is likely to be over £100,000, you might prefer to have your tax code adjusted to reflect the loss of the personal allowance.

Otherwise, you’ll receive the benefit of the personal allowance during the tax year, only to face a high bill when you do your Self-Assessment Tax Return and HMRC take the allowance from you.

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Any questions?

If you’d like a meeting or a Skype call with a Liverpool accountant to discuss this, please give us a ring on 0151 380 3800 or drop us an email at [email protected].

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Added by Jon Davies
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