1 - Income Tax (Personal allowances, Calculating the income tax, Families) Flashcards
Personal allowances
What is it?
Blind person’s allowance?
The personal allowance is deducted after calculating N’s aggregate income less reliefs given by deduction from total income.
Married couple’s allowance is not deducted from total income, but is a tax reducer = its value in tax terms is deducted from N’s tax liability.
Can transfer 10% of personal allowance to a spouse/civil partner as a tax reducer.
Blind person’s allowance - £2,520 available to registered blind people resident in the UK. it is given as a deduction in calculating income in the same way as the personal allowance.
Personal allowances
Eligibility
UK residents, but also the following non-residents claiming against any income taxable in the UK:
- UK citizens
- nationals of countries in EEA
- N’s who are/have been employed in service of the Crown or missionary society
- N employed in service of any territory under Her Majesty’s protection
- residents in CI&IOM
- Previous residents of UK who are resident abroad for sake of their/family member’s health
- Persons whose late spouse/civil partner were in service of the Crown
Anyone paying tax on remittance basis not entitled to personal allowances except if their unremitted overseas income for the year is less than £2,000.
Note: under remittance basis, a person is only taxed on income actually remitted into UK.
Residents of several other countries can claim personal allowances under the provisions of double tax agreements.
Personal allowance
The amount
How it reduces
All qualifying N have personal allowance of £12,570 (21/22)
There is no min age requirement, so even newborn babies qualify.
This allowance is reduced by £1 for every £2 that a person’s adjusted net income exceeds £100,000 (so someone with income £125,140 will have no personal allowance)
Adjusted net income = total income less deductions for loss relief and interest payments
Note: if there is a chargeable gain under a life assurance policy, the full gain is initially included in the calculation of adjusted net income, but only the top-sliced gain is included in the calculation of adjusted net income.
Marriage allowance
A person can transfer 10% of the £12,570 (21/22) allowance to spouse/civil partner.
The £1,260 amount (rounded up from £1,257) is known as marriage allowance or marriage tax allowance - beneficial where one spouse/civil partner has little or no income.
A transfer only permitted where the other spouse does not pay tax higher than the basic rate. Potential tax saving for 21/22 is £252 (20% of £1,260) - given to recipient as a deduction from their tax liability.
Transfer is all or nothing, so surplus wasted when recipient has tax liability less than £252
An election made in this tax year will remain in force for future tax years.
An election can be made within 4 years after, but will only be for that year.
Cannot make election if either spouse/CP has claimed married couple’s allowance.
Married couple’s allowance
Taxpayers are entitled to a married couple’s allowance of £9,125 (21/22) if either spouse born before 6 Apr 1935
The portion of MCA in excess of basic allowance of £3,530 is reduced by £1 for every £2 of adjusted net income over £30,400.
MCA is a tax reducer
Relief is given at 10% - i.e. 10% of allowance is given as a deduction from N’s tax liability
For couples who married before 5/12/2005 - MCA belongs to husband & can be transferred to wife
For couples who married on or after 5/12/2005 & same-sex, allowance given to higher earner.
Personal allowance trap
Where a person has adjusted net income of between £100,000 and £125,140 - the effective marginal rate of income tax is 60%.
This is the higher rate of 40% + an additional 20% as a result of the withdrawal of the personal allowance.
N can reduce impact of this trap by reducing their adjusted net income:
- Can use tax-free investments, such as ISAs to turn taxable investment income into non-taxable income
- make pension payments, subject to relief at source and/or donations to charity under gift aid = will reduce adjusted net income as defined for the purpose of calculating the personal allowance
Clients should be careful about cashing single premium investment bonds above the 5% limit where adjusted net income is between 100,000-125,140
NOTE: while making a personal pension contribution or gift aid donation reduces N’s adjusted net income, neither is actually deducted when it comes to calculation of taxable income. Instead, they will be used to increase the BR & HR band limits.
Married couple’s allowance trap
Similar to personal allowance trap, as MCA is progressively withdrawn if a person’s income for 21/22 exceeds £30,400
The couple’s allowance is reduced by £1 for every £2 of gross income over £30,400 threshold, down to the minimum £3,530.
Pre 5 Dec 2005 rules, the reduction in MCA is determined by husband’s income only
Post 5 Dec 2005 = determined by income of higher earner
Can mitigate same as personal allowance trap - but note, pension contributions can only be made for those aged 75 or under.
Calculating the income tax charge
What is a person’s taxable income?
How do reliefs work?
Total income = N’s taxable income from all sources in a tax year
Certain reliefs and personal allowance are deducted from total income before charging tax = these save tax at the N’s top rate
Other reliefs and allowances are deducted when calculating tax by:
- extending BR & HR tax bands; or
- Making a deduction from the tax liability
The application of tax rates
How many tax rate bands?
What is most important rate?
Impact of extending BR & HR?
Tax is calculated at various tax rates on N’s income:
- 3 main tax rate bands (not Scotland)
- Set annually by Gov, usually changed each year in the Budget
- Most important rate = BASIC RATE (BR), covers most of income for many N (currently £37,700 for next 4 years until 25/26)
- BR & HR limits (£37,700 and £150,000) may be extended by the addition of the gross value of payments into pension schemes, subject to relief at source and donations to charity under gift aid = payments made net of BR tax.
- i.e. N pays £800 in pension, basic rate band is extended by £1,000 (£800 + £200 BR tax deducted) to £37,800 and HR extended to £151,000 = HRT only charged on income over £38,700, ART taxed on income above £151,000.
Personal savings allowance
How much for each tax band?
What is included in PSA?
- *PSA (0% rate)**
- BR @ £1,000, when none of N’s income subject to HR
- HR @ £500, when none of N’s income subject to AR
- AR @ nil
For purpose of PSA, includes:
- interest
- interest element of Purchased Life Annuity payments
- Gains from Life Assurance contracts
Example
Will has employment income £55,700 & savings income £2,000 = total £57,700
Less personal allowance 57,700 - 12,570 = 45,130
37,700 @ 20% = 7,540
5,430 (55700-12570-3700) @ 40% = 2,172
£500 @ 0% = 0
1500 (2000-500) @ 40% = 600
Total income tax = £10,312
Dividend income nil rate band and tax on excess
Difference between PSA & starting rate?
Order income tax charged at?
Savings interest?
Dividend income nil rate band = All taxpayers permitted £2,000 dividend income @ 0% rate
Excess:
BR 7.5%
HR 32.5%
AR 38.1%
PSA & DA count towards the basic & higher-rate band limits
In addition to PSA, a starting rate 0% applies to first £5,000 of savings income for 21/22
Unlike PSA, this starting rate is only available where savings income falls within first £5,000 of taxable income (income in excess of reliefs and allowances).
Income tax is charged, in order:
- Non-savings taxable income
- Savings income
- Dividend income
- Chargeable gains under life assurance policies
So, if non-savings taxable income exceeds £5,000, the starting rate of 0% will NOT apply
Savings income that doesn’t benefit from a 0% rate and exceeds PSA is taxed as:
BR 20%
HR 40%
AR 45%
The tax charge, step-by-step
What are the 6 steps?
Step 1
Calculate all pre-tax income for the year, distinguishing the different income types.
Income is taxed in order:
1. Earnings, pensions, rental income and all other income not classed as savings or dividend
2. Savings income (not chargeable gains under LA) -to help with PLA/savings rate
3. Dividend income
4. Chargeable gains under LA policies (treated separately as highest part of income despite potentially qualifying for PSA)
Step 2
Deduct reliefs deductible from total income, i.e. allowable business & property losses, retirement annuity payments made gross, interest on loans to invest in a close trading company/partnership. Same order as step 1.
Step 3
Deduct personal allowance £12,570 (and blind person’s allowance if applicable)
Step 4
Calculate the amount of any payments for which HR & AR relief given by extended BR & HR bands, namely pension contributions paid net and donations to charity under gift aid. BR & HR are extended by the total of the grossed up payments
Step 5
Calculate the tax on the remaining income, in the order of step 1 (see tax table for amounts)
Step 6
Deduct any tax reducers, i.e. marriage allowance, married couple’s allowance where at least one party to marriage born before 6 Apr 1935.
Scottish and Welsh taxpayers
Scotland
The Scottish Parliament can set the income tax rate and bands that apply to the non-savings and non-dividend income of Scottish taxpayers. The personal allowance (£12/570) is the same as for the rest of the UK. Currently:
£0-£2,097 - Starter @ 19%
£2,098 - £12,726 - Basic @ 20%
£12,727-£31,092 - Intermediate @ 21%
£31,093-£150,000 - Higher @ 41%
Over £150,000 - Top @ 46%
- R03 only covers UK excluding Scotland tax rates
Wales
The National Assembly for Wales can set the income tax rates that apply to non-savings and non-dividend income of Welsh taxpayers, but for 21/22, the Welsh tax rates are the same as rest of UK (excluding Scotland)
Income tax and families
Allowances
Can it impact planning?
Consideration of S/CP as employee/owner?
Marriage and civil partnership
Spouses and civil partners (S/CP) are taxed separately.
- Subject to certain conditions, a person can transfer 10% (£1,260 for 21/22) of their personal allowance to their S/CP = max tax saving would be £252
- If one or both is old enough, may be entitled to married couple’s allowance.
- The main impact of tax on marriage or civil partnership is on CGT and IHT
The existence of marriage/civil partnership can impact planning, especially with the aim to avoid tax. Spouses are often treated as if they are connected, so a benefit of one S/CP may be taxed as if it were paid to the other spouse or partner.
Consider: HMRC will accept the salary of a company employee as a deductible expense, but if a company/business owner employs the spouse (or child) of the owner, HMRC may question the level of remuneration in relation to the work performed.
HMRC have also tried to attack other business arrangements where S/CPs are joint owners of a business or company and HMRC considers the arrangements to be uncommercial, i.e. one party does most of the work, but the other shares the profits = saving income tax/NIC.
Maintenance payments
What is the one exception providing tax relief?
Apart from one exception, there is no tax relief for maintenance payments made to a divorced or separated S/CP, or their children.
The exception is where either party to the marriage was born before 6 April 1935 and the payments are made to a divorced or separated spouse (not to their children).
Relief is given at 10% on payments of up to £3,530 a year.
The recipient is not taxed on the payments.
