Business

How to avoid the 60% tax trap

Tax Corner
A correspondent from HM Revenue and Customs. While 45% is the highest ‘official’ income tax rate, the way the tax-free personal allowance is treated means that some people actually pay an effective tax rate of 60% on some of their income (Yau Ming Low/Getty Images/iStockphoto)

QUESTION: As it approaches the end of the tax year, I am considering giving my head salesman a bonus which will have him earning more than £100,000. I have read that it could be taxed at 60%. Is this correct as I understood the highest rate of income tax was 45%?

ANSWER: If you live in England, Wales or Northern Ireland, you probably think the highest rate of income tax is 45%. While 45% is the highest ‘official’ income tax rate, the way the tax-free personal allowance is treated means that some people actually pay an effective tax rate of 60% on some of their income.

Most people have a standard personal allowance of £12,570 which is the amount of income you do not have to pay tax on each year. But once you earn more than £100,000, your tax-free personal allowance starts to be tapered. It reduces by £1 for every £2 that your adjusted net income exceeds £100,000, and is zero if your income is £125,140 or above.

In real terms, this means that for every £100 of income between £100,000 and £125,140, you only get to take £40 home – £40 is deducted in Income Tax, while another £20 is lost by the tapering of the personal allowance. This amounts to a 60% tax rate. Let’s imagine you earn £110,000 – or £10,000 above the threshold. You would not only pay £4,000 in higher rate tax on the £10,000, but you’d also lose £5,000 of your personal allowance.



And with £5,000 of your personal allowance gone, that portion of your income is now also subject to tax at 40%, costing you another £2,000. In other words, of that £10,000, you’d only get to keep £4,000, which equates to a 60% tax rate.

One of the quickest and simplest ways to bring your taxable income below the threshold is to pay more into your pension before tax year-end. This is a win-win, since you reduce your tax bill and boost your retirement fund at the same time.

Here’s an example. You get a £1,000 pay rise or bonus, which takes your taxable income to £101,000. If you pay that £1,000 into your pension, you won’t enter the 60% tax zone and you’ll get the benefit of a 40% top-up on your contribution, thanks to pension tax relief. You can pay a maximum of £60,000 into your pension each year, and still enjoy tax relief on your contributions.

Malachy McLernon.
Malachy McLernon. Malachy McLernon.

A well timed pension contribution might help you sidestep the higher rate or additional tax band, so you avoid paying more income tax.

It might be very worthwhile you offering to your salesman that the bonus the company proposes to make to him could instead be a pension contribution made by the company on his behalf. This would avoid the salesman falling within the 60% effective tax rate and there can be an employer NIC tax saving for the company.

If you would like to find out more about options available for you, please feel free to contact me at m.mclernon@fpmaab.com.

  • Malachy McLernon (m.mclernon@fpmaab.com) is partner at FPM Accountants. The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.