Date posted: 17th Feb 2025
A lot of businesses will pay high performing employees a year-end bonus before the end of the tax year.
Immediate thoughts of receiving a bonus will lead to considering holidays, home improvements or possibly paying off some debt.
Of course, you will be aware that tax and national insurance is payable on the bonus (sadly!) and you will assume that this is dealt with at source, so what you receive in your hand, will be yours to spend.
However, that is where you may be mistaken, especially if you fall into “the 60% tax trap”.
The 60% tax rate isn’t a published tax rate, but it is an effective rate if your total income exceeds £100,000, including the bonus. This is due to the tapering of the personal allowance, once you earn over £100,000.
This is best illustrated as an example.
Harry’s employment package is £105,000 but he salary sacrifices £5,000 into pension. His salary for tax purposes is therefore £100,000 and has no other sources of income.
Harry has done really well this year and is due to receive a £25,000 bonus before 5 April 2025. Harry works out that he will pay 40% tax and starts to plot how to spend the remaining £15,000 (we are ignoring the 2% national insurance charge for this illustration). However, Harry doesn’t realise that he will have a further £5,000 tax bill coming his way……
Harry has this tax bill as his income for the year will be £125,000. This means that his personal allowance of c£12,500 will be lost as this is reduced by £1 for every £2 earned over £100,000. Therefore, once his tax is calculated at the year end, he will have used the allowance of £12,500 against his salary during the year but as he has lost his entitlement to this, it will bring another £12,500 of income into charge to tax as part of the year end calculations – £12,500 x 40% = £5,000.
The reason that this is known as the 60% tax trap, is that his effective rate of tax on income over £100,000 is 60%.
Harry has paid £10,000 in tax on the bonus via the payroll and a further £5,000 direct to HMRC – so £15,000 in total. £15,000 is 60% of £25,000.
This will come as a shock to Harry, who probably had no idea that this situation existed. If he was aware, then he could accept the extra £5,000 tax charge and only plan to spend £10,000 of his bonus and keep £5,000 aside for tax. Or alternatively, Harry could make a donation to charity to restore some of his personal allowance or elect to pay some or all of the bonus into his pension.
Harry needs tax advice. If you are in a similar situation, please get in touch sooner rather than later.
