Monday, 24 March 2014

WHEN DOES HIGHER RATE TAX START?

Tax rates of more than 100%, higher tax rates at £110,000 than £150,000, frozen allowances for pensioners, and when does higher rate tax start? All figures are at 2014/15 rates.

When does higher rate tax start?
People ask me “When does higher rate tax start?” Often preceded by "I’m confused” and attaching an official document which says, unhelpfully, that basic rate tax ends at £31,865.

The confusion is caused by the Treasury which likes to refer to the ‘basic rate band’ as running from £0 to ££31,865 in 2014/15 but without mentioning that amount is on top of the personal tax allowance. So higher rate tax in 2014/15 begins on income above £41,865 made up of the £10,000 tax-free personal allowance plus the £31,865 basic rate limit. The table shows the personal allowance and the higher rate threshold for the last few years
2010/11
2011/12
2012/13
2013/14
2014/15
2015/16
Personal allowance
£6,475
£7,475
£8,105
£9,440
£10,000
£10,500
Basic rate limit
£37,400
£35,000
£34,370
£32,010
£31,865
£31,785
Higher rate starts
£43,875
£42,475
£42,475
£41,450
£41,865
£42,285

After falling for three years the threshold for higher rate tax is now rising by 1% a year. The result has been that the number of taxpayers paying higher rate tax has risen by has increased by around two million under the Coalition Government. Just over five million will pay it in 2015/16 compared with just over three million in 2010/11 (source: IFS).

What is the marginal tax rate on Child Benefit?
The new Child Benefit High Income Charge is a tax on child benefit where either partner has an income above £50,099. The tax on the child benefit is 1% for each £100 above £50,000 thus reaching 100% of the child benefit as income reaches £60,000.

Child benefit is £20.30 a week (£1055.60 per year) for the first child and £13.40 per week (£696.80 a year) for each other child. So for each £100 rise in income the tax charge is 1% of £1055.60 for those with one child; 1% of £1752.40 for two children, 1% of £2449.20 for three children and so on.

People earning between £50,000 and £60,000 pay income tax at 40% and National Insurance of 2%. If they have a student loan they pay another 9% towards that. So their marginal rate of tax is already 42% or 51% with a student loan. If the tax taken from the child benefit is also added the marginal rate for someone with, for example, three children for each £100 earned is

Income tax £40.00
NI £2.00
CBHIC £24.49
Total £66.49

So for those with three children the marginal rate of tax on each extra £100 is 66.5%. Add on £9 student loan repayment and the marginal rate rises to 75.5%.

Marginal tax rate on each £100 for incomes £50,000 to £60,000 where child benefit received

Normal
With student loan
Children
1
52.6%
  61.6%
2
59.5%
  58.5%
3
66.5%
  75.5%
4
73.5%
  82.5%
5
80.4%
  89.4%
6
87.4%
  96.4%
7
94.4%
103.4%
8
101.3%
110.3%
9
108.3%
117.3%
10
115.3%
124.3%
               
As the table shows everyone in this position pays above the notional top rate of tax of 45% and will pay more than 100% on each extra £100 if they have eight children, or with seven children if they are repaying a student loan. So earn £100 and pay for example, £110.30 in tax. 

Why do I pay 60% tax over £100,000?
The top rate of tax is 45% on incomes above £150,000. But people with income between £100,000 and £120,000 actually pay a marginal rate of income tax of 60% on each extra £2 they earn.

Since 2010/11 the personal allowance has been phased out once income exceeds £100,000. It disappears at the rate of £1 off the personal allowance for each £2 of income above £100,000. So an extra £2 of income is taxed at 40% and also brings down the personal allowance by £1. That brings another £1 of income into tax charged at 40%. So a £2 rise in income results in £3 being taxed at 40% which is £1.20. So £2 of income results in extra income tax of £1.20 which is a rate of 60%.

The marginal rate continues until the personal allowance disappears. In 2014/15 that happens as income hits £120,000. Above that the marginal rate reverts to 40%. And then of course rises to 45% above £150,000.

Why do pensioners pay 30% tax?
Only some, and a declining number, of people over 65 pay a marginal tax rate of 30% on a narrow band of income above £27,000 a year. People born before 6 April 1948 – who are now 66, get a higher personal tax allowance than younger people. The allowance is £10,500 for those born 6 April 1938 to 5 April 1948 and £10,660 for those born before 6 April 1938. These age allowances used to apply at 65 and 75 but from 2013/14 were frozen at their 2012/13 rates and retained only for those born before those dates. The higher age allowance is reduced if income exceeds £27,000 in 2014/15.

The age allowance is reduced at the rate of £1 off for each £2 of extra income. So an extra £2 of income is taxed at 20% and also brings down the age allowance by £1. That brings another £1 of income into tax paid at 20%. So a £2 rise in income results in £3 being taxed at 20% which is 60p. So £2 of income results in extra income tax of 60p which is a rate of 30%.

Once the age allowance is reduced to the personal allowance is then stays at that level. So in 2014/15 the marginal rate applies only to income between £27,000 and £28,000 for the younger age group and between £27,000 and £28,320 for the older group.

In 2015/16 the personal allowance will equal the lower age allowance so the problem will disappear for that age group and will almost certainly vanish for the older group in 2016/17 as the personal allowance rises above £10,660.

Why are tax allowances for pensioners frozen when they are rising for others?
In the past people got a higher personal allowance in the tax year they reached 65 and a slightly higher one that that when they reached 75. But in 2013/14 these age allowances were frozen at their 2012/13 rate and only given to those entitled in 2012/13. The allowance is £10,500 for those born 6 April 1938 to 5 April 1948 and £10,660 for those born before 6 April 1938.

The result is that the tax allowances for those age groups have not risen in 2013/14, 2014/15 and will not rise in 2015/16. By then the personal allowance will be £10,500 for everyone so those born 6 April 1938 to 5 April 1948 will get the same as younger people and in 2016/17 should see their allowance rise above that level. The policy is that it will rise by CPI so probably by 2% or about £210 taking it to £10,710.

That should also mean that the older group born before 6 April 1938 should see their allowance rise – though only by around £50. 

Pensioners with incomes high enough not to get age allowance have of course seen their personal allowance rise by the same amount as younger people.

Version 1.00
24 March 2014




3 comments:

  1. Re the 60% stealth tax on incomes over £100,000 I raised this with the Office of Tax Simplification as a candidate for abolition. It would clearly be fairer to introduce the 45% tax rate at the 100k level instead. Although the OTS does not undertake to reply to suggestions they did in fact send me a reply a few days later. To paraphrase, the upshot was that the OTS accepted that the tapering away of personal allowance was unfair and should be a candidate for abolition - But, nothing can be done because the government needs the money. If this is the attitude then the OTS might as well pack uo and go home. Surely the point should be to remove complicated stealth taxes and if necessary increase headline tax rates to compensate.

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    1. Completely agree. What's more, the effective 60% tax rate simply acts as a disincentive for all those with earnings around or below the £100,000 mark ... why bother taking that job that pays £10K more if you're only going to keep £4k of it? It wasn't such a big deal under Labour when the Personal Allowance was much smaller, but this sneaky tax rate now affects far more people. For what it's worth, Facebook group has been set up by some people who'd like it banned https://www.facebook.com/scrap60.

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  2. The rates of Income Tax you pay depend on how much taxable income you have above your Personal Allowance. The idea is that high-income taxpayers can shoulder the burden of a high tax rate. Low-income taxpayers pay less because they can't afford to pay high taxes. If you can’t avoid paying the higher rate of tax and you don’t have enough money to do it, turn to cash lenders on the Web. Otherwise you’ll have to pay fines.

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