Date posted: 23rd Jul 2024
Recent media coverage has suggested that around 500,000 individuals are caught in the 60% tax trap.
Essentially, this means that an individual is paying 60% tax on every £1 earned. That is before national insurance and student loan repayments are considered.
Such a situation arises when the individual earns between £100,000 and £125,000.
Whilst the 60% tax rate is not an official rate of tax, it arises as a result of the 40% tax due as a higher rate taxpayer but also the withdrawal of an individual’s personal allowance (of £12,570) once they start to earn over £100,000. The allowance is eroded at a rate of £1 for every £2 earned over £100,000.
As an example, Sally earns £100,000 from employment but has no other income.
Sally is entitled to her full personal allowance of £12,570. This is the amount that she can earn, tax free.
Her employer wishes to pay Sally a bonus of £25,140 for good performance. Sally is very grateful, and her employer deducts the usual 40% tax from the bonus, leaving Sally with around £15,000 (ignoring national insurance).
However, Sally is not entitled to any personal allowance now – her income is £125,140 for the year, which means that her personal allowance is eroded. The withdrawal of this allowance, means that the £12,570 that Sally believed was tax free, is now subject to tax. Therefore, Sally has to pay a further tax charge of £12,570 x 40% = c£5,000.
As a result of receiving a bonus of c£25k, Sally has paid £15k in tax (£10k via the payroll and £5k via a tax demand) – so 60%.
Sally could have put some of her bonus into pension to save such a high tax charge. She could perhaps ask her employer for an electric company car, which is very tax efficient. Sally may also be a very charitable person and could have paid gift aid donations, which would have helped.
There may be other tax relief options available to Sally such as tax efficient (but risky) EIS or SEIS type investments.
As ever, personal circumstances are unique, so give us a call if you wish to discuss your own personal tax position.
