M2&M3: Income Tax computation

Question 1

What is the process for calculating income tax?

Answer 1

Firstly, the income earned by an individual which is within the scope of income tax is categorised into three types:
- Non- savings income (which includes employment, pension, property and trading income);
- Savings income (which includes bank and building society interest) and
- Dividend income.

These three types of income are combined together to calculate total income.

Secondly, the taxpayer may be entitled to
certain deductions from total income to calculate net income and may then be entitled to deduct the
personal allowance before calculating taxable income.

Question 2

What is the personal allowance and when will it be reduced?

Answer 2

The personal allowance represents the amount of income which is tax-free for the taxpayer each year.

If an individual’s net income exceeds £100,000, their personal allowance is reduced by £1 for every £2
above £100,000. It is reduced to zero if their net income is higher than £125,140 for the tax year.

Question 3

What is the easiest way to carry out a taxable income calculation?

Answer 3

1. Gather all sources of income to calculate total income.
2. Deduct specific amounts eligible for tax relief to calculate net income.
3. Allocate the personal allowance to determine taxable income.

Question 4

What are the main examples of non-savings income?

Answer 4

1. Trading income - Individuals running businesses as sole traders or partners in partnerships receive trading income. This income is based on the accounting profit of the business, adjusted for tax
   purposes. Partners in a partnership are taxed based on their share of the taxable trading profits
   of the partnership.
2. Employment Income - Employment income comprises salary, bonuses and taxable benefits (e.g., company car) and can be reduced by employment-related expenses. This income is received after tax deductions through the Pay as You Earn (PAYE) system. Taxable benefits, typically non-cash payments, are assigned a cash value, and the corresponding tax is generally deducted through PAYE.
3. Pension Income - Pension income includes state pensions provided by the UK government and pensions from private schemes. Private pension scheme administrators deduct income tax through PAYE when making monthly payments.
4. Property Income - Income generated from renting out property or land is considered property income. Individuals who earn income through property rentals are taxed on their rental receipts after deducting
   necessary expenses.

Question 5

How is savings income included in the income tax computation?

Answer 5

• Interest on joint accounts is shared equally between account-holders
• Income received from ISAs is entirely exempt from income tax and is not included in the
  income tax computation

Question 6

What types of non-dividend income can an individual have?

Answer 6

Non-savings and savings income.

Question 7

What are the main examples of non-savings income?

Answer 7

• Trading income
• Employment income
• Pension income
• Property income

Question 8

How is savings income included in the income tax computation?

Answer 8

Under savings income pro-forma:

Either joint accounts (tax halved for each individual) or ISA’s (tax-free)

Question 9

What are the two types of ‘deductions from total income’ and how do they impact the income tax computation?

Answer 9

1) qualifying interest payments.
2) gifts of shares, land or buildings to charity.

Question 10

Which interest payments are qualifying interest payments?

Answer 10

Interest payments on loans for the following purposes can be deducted from total income for the tax
year:
* purchasing of plant and machinery by a partner for use in the trade of the partnership.
* acquiring an interest in a close company, or
* buying a share in a partnership.

Question 11

What are the three ways to make tax-efficient donations to charity?

Answer 11

1. Gifts of listed shares, land, or buildings.
2. Donations under a payroll deduction scheme.
3. Donations made under the Gift Aid scheme (detail in the tax liability calculation module).

Question 12

How can gifts of listed shares, land or buildings impact the income tax computation?

Answer 12

Donating these types of asset to a charity result in tax relief as a deduction from total income, based
on the assets’ market value at the time of the gift.

Question 13

How does donating to charity through your payroll work?

& How does it affect the income tax computation?

Answer 13

Employers can offer Give-As-You-Earn, allowing employees to make tax-efficient donations directly from their gross wages.

IT CALC: Reduce employment income by the amount. This is the only deduction.

Question 14

How is income allocated to each of the income tax bands?

Answer 14

All of the taxable income is processed through the following bands in order:
1. Basic rate band (UK 20%)
2. Higher rate band (UK 40%)
3. Additional rate band (UK 45%)

Question 15

What happens to taxable income when you do Gift aid?

Answer 15

NOTHING.

This affects tax liability and not taxable income.

Question 16

State the income tax pro-forma

Answer 16

NSI SI Div Tax Paid

Trading income
Employment income (-GAYE)
Property Income
Pension Income
Bank interest
Dividend income

Total income (1)
- Qualifying interest payments

Net income (2)

• Personal Allowance *

Taxable income (3)

Personal allowance* Check if income goes between 100,000 - 125,140 as its a working as it tapers down.

Question 17

What are the income tax rates for different categories of taxable incomes?

Answer 17

Non-savings income: 20% [£0 - £37,700], 40% [£37,701 - £125,140], 45% [125,141+]

Savings income: 20% [£0 - £37,700], 40% [£37,701 - £125,140], 45% [125,141+]

Dividend income: 8.75% [£0 - £37,700], 33.75% [37,701 - 125,140], 39.75% [125,141+]

Question 18

When could an individual be eligible for a refund of overpaid income tax?

Answer 18

• an employee has had more tax deducted through PAYE than their final liability indicates.
• when an individual has low income or when some income is ultimately taxed at a lower rate
  than the tax deducted at source.

Question 19

How do you calculate the tax liability on savings income?

Answer 19

1) Determine the income tax band that the taxpayer is in first.

2) Apply Basic Rate £1000, Higher rate band £500 or Additional rate band of £0 to the savings allowance before carrying on.

e.g. starting in 40% apply 0% to £500 and then apply rest as normal.

Question 20

What are the key tips to look over when you have completed the income tax calc?

Answer 20

• Ensure that taxable income is allocated to all three bands where necessary.
• Identify if the starter rate and / or savings allowance applies.
• Use the correct income tax rates for each band.
• Remember the dividend allowance always applies if there are dividends.

Question 21

Who does the starting rate apply to?

Answer 21

Those with taxable non-savings income below £5,000.

Designed to help individuals with minimal non-savings income pay less tax.

Question 22

How is income tax on dividend income calculated?

Answer 22

First 1,000 is tax free at 0%

The rest is taxed at 8.75%, 33.75% and 39.35% depending on basic, higher and additional rate.

Question 23

How does a Gift Aid donation impact the income tax calculation for basic rate, higher rate and additional rate taxpayers?

Answer 23

All gift aid is 20% initially, higher rate and additional rate payers have to extend their tax bands by the gross donation amount.

e.g. basic rate taxpayer wishes a charity to receive £1,000, they only need to pay £800 in
cash (£1,000 - £200 basic rate income tax). The charity then recovers the remaining £200 from HMRC (the amount of basic rate tax paid by the donor).

For higher rate taxpayers, £100 (gross donation) is added to the 37,700 band and additional rate, £100 is added to the 125,140 meaning new tax numbers of 37,800 and 125,240.

Question 24

How does the marriage allowance impact the income tax calculation?

Answer 24

The Marriage Allowance allows married couples or civil partners to transfer £1,260 of their personal
allowance.

This transfer can benefit couples when one partner has lower income and does not fully
utilise their personal allowance.

• The recipient spouse deducts 20% of the transferred amount (£252) from their total income
  tax liability for the tax year.
• This election is advantageous when one partner has low income or income within the starting
  rate for savings, savings allowance, or dividend allowance after deducting the personal
  allowance.

Requirement = The recipient of the transfer must be a basic rate taxpayer.

Question 25

When do different tax rates apply for Scottish and Welsh taxpayers?

Answer 25

ONLY on Non-savings income:

Question 26

How do you calculate the income tax liability for a Scottish taxpayer?

Answer 26

Instead of the 3 income tax rates used in England and Wales.

We calculate a Scotland income tax liability using their five income tax rates: 19%, 20%, 21%, 42%, and 47%.

• Savings and dividend income of Scottish taxpayers are taxed at UK rates.

Question 27

What are the conditions that need to be satisfied for gift aid donation?

Answer 27

1. The gift must be irrevocable and a true gift, with no personal benefit to the taxpayer.
2. The taxpayer should have paid sufficient UK tax to cover the 20% basic rate tax top-up paid to
   the charity by HMRC. If not, HMRC may raise an assessment for the shortfall on the taxpayer.

Question 28

What is the requirement to get marriage allowance?

Answer 28

Both people have to be in basic rate band.

Cannot pay higher or additional tax on any income to get this.

Question 29

How much money can be invested in a Junior ISA tax-free?

Answer 29

Up to £9000 per tax year.

Question 30

How will the assessment question trick you when answering?

Answer 30

By asking to input different amounts e.g. net income or taxable income or savings income etc.