Tax doesn't have to be taxing, but it is

Martin Macario contemplates the forthcoming 60% effective rate of income tax 

It is well publicised that a new 50% additional rate of income tax becomes effective from 6 April 2010.  Most of us however can breathe a sigh of relief as this additional rate is only applicable to individuals who have taxable earnings in excess of £150,000 in the 2010/11 fiscal year.

What is less well known is that that the personal allowance i.e. the amount an individual can earn before having to pay tax, which is currently £6,475, is going to be reduced by £1 for every £2 of earnings that an individual receives that is in excess of £100,000.  For example, an individual who earns say £105,000 in 2010/11 will see his personal allowance reduced by £2,500.  The result of this restriction is that the taxpayer in question actually pays an effective tax rate of 60% on the £5,000 of earnings that exceed £100,000.  This 60% rate applies for the range £100,001 to £112,950.  The effective rate then reverts back to 40% up to £150,000.  

This is an alarming statistic and as an aside, quite how employers are going to implement this through the Pay As You Earn (PAYE) system, if appropriate, is likely to be a real challenge.  It does seem a strange piece of legislation and certainly does not fit with ‘tax-simplification’.  

Nevertheless, the key point here is that whilst there may not be too many individuals in the UK who earn more than £150,000 there are a considerable number of taxpayers that do achieve annual earnings of more than £100,000. 

Fortunately, the restrictions on pension contributions are only applicable to individuals earning more than £150,000, assuming other conditions are met.  Therefore, for individuals who fall into the 60% category it is possible, assuming they have taken independent financial advice, to reduce taxable earnings to below £100,000 by way of pension contributions, and thus save tax at 60%.

National Insurance contributions are also increasing and all self-employed business owners should once again carefully consider the pros and cons of incorporating their business now the pendulum is once again swinging in favour of incorporated entities.