Spotlight on taxation
1 February 2011
Higher rates of tax occur when a person's taxable income moves from one tax band to another. For example, the basic rate band is £37,400 and income above this is taxable at 40%. So every £1 of additional income is taxed at 40% which then becomes the marginal rate.
The charge is greater where income exceeds £100,000. Here the personal allowance of £6,475 is gradually reduced to nil so that a person with income of £112,950 or more is not entitled to any personal allowance. The effective marginal rate of tax is 60% (higher rate tax of 40% plus a further 20% due to the withdrawal of the personal allowance). Those with incomes over £150,000 have a marginal tax rate of 50%.
Individuals should pay particular attention to their marginal rate of tax because it is often possible to plan to avoid these high rates - either by controlling your income or maximizing your tax claims.
One of the most effective ways to reduce your marginal rate of tax is to pay a pension contribution. For example if your income is £110,000 and you pay a gross pension contribution of £10,000 the actual cost to you will be only £4,000.
The same principle applies to donations under Gift Aid - you get to choose where your money goes rather than donating to the government!
As a business owner, you can use a limited company to control the amount and the timing of your income. For example, you can pay dividends in tax years when your marginal rate is lower. And you can structure the ownership of the company so that income is paid to family members with lower marginal tax rates, although you must of course be careful to keep within the tax rules.
Married couples and civil partnerships should ensure that income from savings, shares and property is taxable on the spouse or partner with the lowest marginal rate. This can be done by transferring assets between them without a tax charge.
A gain on an investment bond will also be taxable at the marginal rate and may affect age allowance. So consider assigning a bond to a family member who has a lower marginal tax rate before it is cashed in.
Investing in an ISA can reduce your marginal rate of tax in future years because interest and dividends from capital invested in an ISA are not included in your taxable income.
It is certainly worth seeking the advice of a tax expert to make sure you’re not paying more tax than you need.
Graham Sillett can be contacted at Lovewell Blake on 01603 663300 or e-mail email@example.com