Income Tax Flashcards
What is regarded as ‘income?’
Money will be regarded as income if there is an element of recurrence, like a monthly salary or interest received on a bank account.
Who pays income tax?
Individuals, including sole traders based on trading profits
Partners - responsible for tax due on their individual share of the partnership profits; apportion trading profits between partners in accordance with their shares in the income profits
Personal representatives - pay the deceased’s outstanding income tax and income tax chargeable during the administration of the estate
Trustees - pay income tax on income produced by the trust
When must income tax be paid?
The taxpayer will submit a tax return to HMRC by 31 January following the tax year to which the return relates (5th April the prior year)
What are the three categories of income?
Non-savings, non-dividend income (NSNDI)
Savings income
Dividend income
What are the five main steps to calculate income tax liability?
Step 1: Calculate total income
Step 2: Deduct any allowable reliefs to give net income
Step 3: Deduct any personal allowance to give taxable income
Step 4: Separate NSNDI, savings and dividend income and calculate the tax on each type at the applicable rate
Step 5: Add together the amounts of tax from Step 4 to give the taxpayer’s overall tax liability
Having calculated the taxpayer’s overall liability, reduce that liability by any income tax deducted at source (and therefore paid direct to HMRC). The resulting figure is the income tax which the taxpayer is obliged to pay to HMRC.
For Step 1, how do we calculate total income?
Find out what the sources of income are, calculate the income arising under each and add them together
Key sources of income are:
- Trading income – applies to sole traders and partnerships
- Property income - rents
- Savings and investment income
- Employment and pensions income – includes sick and maternity pay
- Miscellaneous income
For Step 1, what is important to remember about PAYE?
Tax will be deducted at source for employment income through PAYE, as the employer pays this directly to HMRC. As such, we must ‘gross up’ any sum received by the employee to find the original sum from which tax was deducted – this gross goes into the calculation of total income
For Step 2, what is the most relevant allowable relief?
Total income less allowable reliefs = net income
Interest payments on qualifying loans are a main type of allowable relief
A qualifying loan includes:
- A loan to buy a share in a partnership, or to contribute capital or make a loan to a partnership
- A loan to invest in a close trading company
- A loan to PRs to pay inheritance tax
For Step 3, what is the ‘personal allowance?’
1) Can earn up to £12,570 each year before paying income tax – this personal allowance is deducted from net income to give a taxable income figure
2) Applied in the following order:
- To NSNDI
- If there is surplus, against savings income
- Then against dividend income
Where income exceeds £100,000, the personal allowance is reduced by £1 for every £2 of income above it. When income reaches £125,140, no personal allowance applies
Adjusted personal allowance = £12,570 - (net income - £100,000/2)
What allowance does a registered blind taxpayer receive?
A registered blind taxpayer receives an allowance of £3070 to be subtracted from net income, in addition to personal allowance
What is the personal savings allowance?
A personal savings allowance allows an amount of savings income to be tax free:
- Basic rate taxpayer - £1000 PSA
- Higher rate taxpayer (£37701 - £125,140) - £500 PSA
- Additional rate – no allowance
This is applied later, in Step 4
What is the dividend allowance?
All taxpayers, regardless of band, are allowed the first £500 of dividend income tax free
For Step 4, what is the order of taxation and how do we calculate taxable NSNDI?
Taxable income less savings and dividend income = taxable NSNDI
Order of taxation:
- NSNDI (taxed first)
- Savings income
- Dividend income
Remember that the amount of taxable income at this stage will determine what level of personal savings allowance applies (if any)
What are the tax rates and bands for NSNDI?
Basic rate of 20% = £0-£37,700
Higher rate of 40% = £37,701-£125,140
Additional rate of 45% = over £125,140
What are the tax rates and bands for savings income?
Starting rate for savings of 0% = £0-£5000
Savings basic rate of 20% = £5001-£37,700
Savings higher rate of 40% = £37,701-£125,140
Savings additional rate of 45% = over £125,140
How do we calculate tax on savings income?
Savings income less PSA (taxed at 0%) = remaining taxable savings income
So if A has £45,000 NSNDI and £5000 in savings:
1) Calculate the tax on £45000 NSNDI
2) £5000 - £500 (PSA) = £4500 to tax at 40% (as total of savings and NSNDI exceeds basic rate threshold)
What is a good point to remember about the personal savings allowance + savings income?
Remember that the PSA comes off the first bit of savings income, so if the amount straddles two tax rates, this means more will be taxed at higher rate
Example - After other income is taxed (£35,500), A has £2200 of the basic rate band left. A has £8000 in savings income.
The savings allowance of £500 is deducted now, leaving A with £7500 taxable savings income (£1700 at basic rate and £5800 at higher rate)
What are the tax rates and bands for dividend income?
Dividend ordinary rate of 8.75% = £0-£37,700
Dividend upper rate of 33.75% = £37,701-£125,140
Dividend additional rate of 39.35% = over £125,140
How do we calculate dividend income?
Dividend income less dividend allowance (taxed at 0%) = remaining taxable dividend income
So if A has £45,000 NSNDI and £5000 in savings and £5000 in dividend income:
1) Calculate the tax on £45000 NSNDI
2) Savings = £5000 - £500 (PSA) = £4500 to tax at 40% (as total of savings and NSNDI exceeds basic rate threshold)
3) Dividend = £5000 - £5000 (dividend allowance) = £4500 at 33.75% (as total of savings and NSNDI and dividend income is within higher rate threshold)
What is a good point to remember about the dividend allowance + dividend income?
Remember that the dividend allowance comes off the first bit of dividend income, so if the amount straddles two tax rates, this means more will be taxed at higher rate
Example - After other income is taxed (£35,500), A has £2200 of the basic rate band left. A has £8000 in dividend income. The dividend allowance of £500 is deducted now, leaving A with £7500 taxable dividend income (£1700 at ordinary rate and £5800 at upper rate)
What happens at Step 5?
Add the calculated tax for NSNDI, savings income and dividend income together
How are sole traders taxed?
Sole traders are almost always subject to income tax and may have to register for VAT if they make chargeable supplies exceeding £90,000 in any period of 12 months
Their tax will be calculated by reference to their trading profit
Broadly, how is the income tax of a partner of a partnership calculated?
Calculating the income tax payable by a partner is done by:
1) The partnership’s trading profit will be calculated in the same way as trading profit for a sole trader. By way of recap, the formula is:
- Chargeable receipts LESS deductible expenditure LESS capital allowances = trading profit/loss
2) The trading profit is then shared between the partners in accordance with their
agreement (or, if there is no agreement, the Partnership Act 1890). There are two
elements to this: the agreement may well set out what will be paid first, for example
salaries, interest on capital, and finally any remaining profit. The agreement should also set out each partner’s percentage share of the profits.
3) Each partner will include this figure on their tax return and will be assessed in the
ordinary way for income tax, taking account of any applicable reliefs and allowances
LLPs are treated the same as ordinary partnerships for income tax purposes
What are some other relevant points about the taxation of directors and other employees?
1) Employment income includes earnings which means all benefits received by the employee which derive from their employment as a reward for their services
2) Includes:
- Non-cash benefits – use of a company car
- Rent free or low rent accommodation won’t be charged for tax if:
- (i) it is necessary for the employee to live on the premises in order to perform their duties, for example, certain caretakers; or
- (ii) the accommodation is provided so that the employee can perform their duties better and it is customary in that type of employment to have their accommodation provided, for example, a police officer.
- Bonuses
- Tips
- Compensation for unfair dismissal (after first tax free £30,000)
3) Employees can only deduct expenditure which is incurred wholly, exclusively and necessarily in performance of their duties; stricter test than for trading income
- Contributions to an occupational pension scheme or travel expenses for travelling from one place of work to another would generally be deductible due a modification of the test for these specifically
