Many people have heard that since 6 April 2010, those with ‘total incomes’ in excess of £150,000 will pay the new 50% income tax rate on income in excess of that limit. The Government leads us to believe that only 300,000 taxpayers are affected, which is around 3% of the population.

However, what is not widely appreciated is that at least 600,000 people have incomes of more than £100,000 and will therefore be caught by a change which withdraws the basic personal allowance! The basic personal allowance is the amount of income a person can receive without paying any income tax. For tax year 20010/2011 the personal allowance is £6,475 for those under 65. The plan is to reduce this amount gradually for those with incomes in excess of £100,000 and this results in an effective 60% income tax rate on a slice of income of about £13,000, sitting on top of the first £100,000 of income.

The 60% effective tax rate is because the personal allowance is reduced at the rate of £1 for every £2 of income over £100,000, until the personal allowance has disappeared. So that extra £2 of income will bear the usual tax rate of 40% which is 80p and also trigger the removal of £1 of personal allowance, which would have saved tax at 40p. Therefore out of that extra £2 of income, £1.20 would have been paid in tax and this equates to 60%. The income caught in this 60% trap is effectively the basic personal allowance x 2, which is around £13,000. This 60% rate is effectively sandwiched in the middle of the 40% rate that applies for incomes in excess of approximately £38,000 and the new £150,000 threshold, where the new 50% rate kicks in.

Methods to reduce gross income to avoid losing the personal allowance include making a payment to charity, where the grossed up amount of the individual’s gift aid contribution will be deducted from income, as will the grossed up amount of an individual’s pension contributions, which have received tax relief at source.

This is a really nasty change in the tax system, but there are opportunities to reduce taxable income and the following could be considered:-

1. Ensuring that taxable income is minimised. ISA’s and capital gains/ orientated collectives e.g. unit trusts/ mutual funds aimed at capital growth will look attractive, although investment risk must be considered.
   
   
2. Consider tax deferred investments that give some control over the timing of the tax liabilities. Examples here include UK and offshore single premium insurance company bonds. Investors are not assessed on portfolio income, as it accrues to a life fund, but only when chargeable events are triggered and this is generally only when the bond is encashed or withdrawals of more than 5% of the amount of the original investment are made each year.
   
   
3. For couples, ensure that income producing investments or those that are taxed under the income tax regime, are owned by the lower taxpayer. This can be applied to bank accounts, collectives and investment bonds.
   
   
4. For those in business, paying the lower earner salary justified by work done (so as to satisfy the ‘wholly and exclusively’ test for deductibility) is worth considering. Where each of a couple have a stake in the business as partners or shareholders, splitting profit distribution by profit sharing or dividend payment looks especially attractive, given the HMRC decision not to bring in income splitting legislation following their defeat in the Arctic Systems Case.

If you would be interested in meeting one of our Wealth Management Team to review your financial position and to consider the various mitigation strategies available, including those mentioned above then why not give Seddons Wealth Management a call for a free initial consultation on 01376 340484 and speak to Rob Jones.