Ross Brooke Financial Services

Loss of Personal Allowance
By Michael Roberts - 18th May 2009

What is the Personal Allowance?

Each year, everyone in the UK is entitled to earn a certain amount before they start to pay Income Tax. The Personal Allowance normally increases each year and for the 2009/2010 tax year, this amount is £6,475. For those over age 65 and 75 and earning less than £22,900 the allowance increases to £9,490 and £9,640 respectively.

However, from 6th April 2010, the personal allowance will be reduced by £1 for every £2 of earnings in excess of £100,000. So in other words, assuming the Personal Allowance will increase to around £7,000 next year, if your earnings will be in excess of around £114,000 next year, you will lose your tax free Personal Allowance and will pay tax on everything you earn. If you earn between £100,000 and £114,000, you will lose some of your Personal Allowance.

This equates to an effective tax rate of 60% on earnings between £100,000 and £114,000. This is explained below, and assumes the Personal Allowance will be £7,000 for the 2010/2011 tax year.

How does the 60% Tax Rate Work?

For every £2 you earn in excess of the £100,000 limit, you will lose £1 of your tax free Personal Allowance. So, if you were to earn £114,000, you would have £14,000 above the £100,000 limit, which would be taxable at the 40% rate, so:

£14,000 x 40% = £5,600 tax

However, you would also have lost all of the £7,000 tax free Personal Allowance, so this would also be taxable at the higher rate:

£7,000 x 40% = £2,800 tax

The total additional tax as a result of earning £14,000 over the £100,000 limit is therefore:

£2,800 + £5,600 = £8,400 which equates to 60% of the £14,000 earnings which is over the £100,000 limit.

If, for example, you had a basic salary of £100,000 and receive a bonus of £14,000, you are likely to be rather disappointed when you open your pay slip and find that 60% of your bonus has been taken in tax.

Is there any Good News?

The good news is that you could potentially avoid this punitive 60% tax by using a salary sacrifice arrangement. However this does have other implications therefore it is important to consider the matter carefully before you do anything, and we would strongly recommend that you seek advice first.

If you would like to discuss how this issue will affect you, please do Contact Us.

Disclaimer

This article is based upon our understanding of the current legislation, which is subject to change. This article is intended as a general guide to the new rules. The legislation is complex therefore we would recommend that you ask us for specific advice on your individual circumstances.