T81 - The New 50% Rate

(this article was published in November 2009 on the Dentinal Tubules website

Winston Churchill once said, "We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle."

Whatever his views were, our current government certainly seems to believe that increasing taxes on higher earners is necessary.

From 2010/2011, we will be subject to a new income tax regime, which will see higher earners subject to increased taxation.

Broadly speaking, there are two main changes.

The first is the reduction of an individual’s personal allowance. For 2010/11, the personal allowance of £6,475 will be subject to an income limit of £100,000. An individual’s personal allowance will be reduced by £1 for every £2 of gross income they have above the income limit. Therefore, for those with taxable incomes over £112,950, they will lose their entitlement to the personal allowance completely. (Up to 2010/2011 of course, you pay no tax on the first £6,475 of your taxable income).

The second is the introduction of a so called "additional" tax rate of 50% on that part of an individual’s taxable income that exceeds £150,000.

Let’s see the effect of this in a simple example:

£

Paul’s taxable income is 103,000.

Less Personal allowance 6,475

Less reduction in personal allowance -1,500 (£103,000 - £100,000)/2

Taxable 98,025

Tax on:

37,400 @ 20% 7,480

60,625 @ 40% 24,250

98,025

Total income tax 31,730

If Paul’s income had been £200,000, he would have lost all of his personal allowance and in addition, the 50% rate would also apply.

Paul’s taxable income is 200,000.

Personal allowance 0 (£200,000 - £100,000)/2 is more than £6,475.

Taxable 200,000

Tax on:

37,400 @ 20% 7,480

112,600 @ 40% 45,040

50,000 @ 50% 25,000

200,000

Total income tax 77,520

What you may think of doing is to pay into your personal pension plan, to stop your taxable income exceeding £100,000. Alas, Gordon Brown thought of this and has introduced new pension legislation to prevent you doing just that.

From 2011, pension tax relief will be tapered away for those earning more than £150,000, so those on £180,000 will receive only basic rate tax relief. The precise way in which this will work has yet to be announced.

However, until then, we have the new anti-forestalling rules to keep us entertained.

To stop higher earners paying into their pension schemes between now and April 2011, those earning more than £150,000, who change their normal pattern of regular pension contributions and pay in more than £20,000 may be penalised.

There are two exemptions to this:

Firstly, any existing regular contributions – defined as quarterly or more frequent – will continue to attract higher rate relief even if they add up to more than £20,000 over the year. For example, someone paying £3,000 a month into their pension will continue to get 40 per cent tax relief. These needed to have been place at 22 April 2009.

Additionally, contributions that increase in line with earnings or at a fixed annual rate as per contractual terms are also exempt.

The rules surrounding tax relief for high earners (over £150,000) and who have been making substantial pension contributions which do not qualify as being regular (monthly) have just been amended recently.

For people who have taxable profits in excess of £150,000 in the relevant tax years, and who have been making large pension contributions not deemed to be regular, the pension contribution that can be made in 2009/2010 is the lower of the following:

1. £30,000, or

2. The average pension contributions made over the last three tax years (06/07, 07/08 and 08/09), or

3. Earnings in the tax year of contribution.

The above should detail that this area is far from simple and expert advice should always be sought.

Mac Kotecha (FCA) is a Chartered Accountant and Chartered Financial Planner who deals exclusively with dentists and has been established for over 27 years. His company offers Accountancy, Taxation & Payroll services in addition to invaluable advice on practice management, buying/setting up a practice and other dental issues. He can also advise on pensions, investments, long term care, income protection, IHT mitigation, wills and Critical Illness, amongst other things.

Contact him on 020 8346 0391 or go to www.specialistdentalaccountants.co.uk to learn more.