Although the official top rate of UK income tax is currently 45% (following the reduction from 50% on 6 April 2013) certain situations can result in surprisingly higher marginal tax rates being potentially suffered.
There are a number of traps surrounding personal allowances and child benefit which lie in wait for unwary taxpayers that are identified below.
1.Personal Allowance Trap
The basic personal allowance for the 2013/14 tax year is £9,440 but this gradually reduces to NIL where an individual’s income exceeds £100,000. The allowance is reduced by £1 for every £2 that a taxpayer’s income exceeds £100,000 until it reaches £118,880 ~ at which stage the personal allowance is withdrawn completely! Therefore because taxpayers are effectively being taxed on one and half times the actual amount of income received above £100,000, the normal rate of 40% effectively increases to 60%. Factor in national insurance contributions and this rises to a breathtaking 62%.
2.Loss of Age Allowance
Taxpayers born between 6 April 1938 and 5 April 1948 are normally entitled to an age-related allowance of £10,500 for 2013/14 (£10,660 for individuals born before 6 April 1938). However, where a person’s taxable income exceeds £26,100 these allowances are gradually reduced by £1 for every £2 of income above £26,100 until the normal personal allowance of £9,440 is reached. This means that although an individual over 65 with income of (say) £30,000 should only be liable at the 20% basic tax rate, certain income above £26,100 is effectively taxed at 30%.
Note however, as part of the Treasury’s tax simplification programme, the above situation will cease to apply once the normal personal allowance reaches the current level of the age allowances. Thereafter taxpayers of all ages will qualify for a unified personal allowance.
3.Loss of Child Benefit
Child benefit claimants with income between £50,000 and £60,000 will have their benefit clawed-back by 1% for every £100 that their income exceeds £50,000. For example, a married couple with three children where the highest earner receives £58,000 of income will find that their child benefit for a complete year will reduce from £2,449 to £490. Therefore the £1,959 loss of child benefit will result in an overall marginal tax rate on the £8,000 income of 66.5% !
Income for the purpose of the High Income Child Benefit charge includes all taxable income, including taxable benefits, rental income and taxable investment income less the gross equivalent of any pension contributions paid. The claw-back of child benefit applies to the spouse or partner with the largest income for a tax year.
The current rates of Child Benefit are frozen until 6 April 2014 when they will be increased by 1% for 2014/15 and a further 1% for 2015/16.