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Why is there a 60% income tax rate?

Recent headlines have been bringing marginal tax rates back into the spotlight. The tapering of Personal Allowances combined with rapid inflation seems to create a higher tax rate of 60%.

However, the 60% tax rate isn’t really new – it’s been around in some form since the 2010-2011 tax year. It’s not a glitch in personal allowance legislation, as suggested by The Times. At the time, the legislation was designed specifically to raise more revenue while maintaining the £150,000 threshold for the newer 45% additional tax rate.

However, The Sunday Telegraph wasn’t wrong to suggest that at least a million people could find themselves paying 60% income tax
within the next few years. In this blog, we’ll go into detail about the 60% income tax rate, explaining who is affected and what you can do to avoid it.

What is the 60% income tax trap?

Every worker in the UK is entitled to a Personal Allowance of money that they can earn tax-free. Anything over this amount – which is £12,570 for the current tax year – is taxed at either the 20% basic rate, the 40% higher rate, or the 45% additional tax rate. The amount of income tax you pay depends on the amount you earn above the respective tax thresholds.

However, what many people may not be aware of is that there’s a tapering scale that chips away your Personal Allowance if your annual income exceeds £100,000. For every £2 you earn above this, you lose £1 of your tax-free allowance. This means that if your earnings reach £125,140, you’ll have lost the entire Personal Allowance left – which works out as a 60% tax rate.

Here’s an example of how the 60% income tax trap
could affect an employee in 2022-2023:

  • 1) Sandra earns an annual income of £100,000
    and is entitled to the Personal Allowance.
  • 2) She receives an unexpected bonus of £10,000, taking her total income to £110,000.
  • 3) Sandra will lose £1 of every £2
    she earned over £100,000 – meaning that her Personal Allowance
    will be reduced by £5,000 (she now only earns £7,570 tax-free).
  • 4) She already has to pay 40% tax on her earnings over £50,271 – so £4,000 of her bonus will be taken as income tax.
  • 5) On top of this, Sandra will have to pay £2,000
    of the amount no longer covered by her Personal Allowance (40% of £5,000).
  • 6) In total, Sandra would pay £6,000 of her £10,000 bonus in tax – making it a 60% tax rate.

Of course, if Sandra received any bonuses totalling £25,140
or more (£12,570 multiplied by two), then she would lose all of her Personal Allowance. Though it doesn’t happen too often or to too many people, employees can be caught out by things like bonuses, company benefits, and earning additional income from other sources at the same time as their primary salary.

How to avoid the 60% income tax rate

While relatively few people previously fell into the 60% income tax sinkhole, this number is likely to increase over the next couple of years due to soaring inflation rates. If you would rather not pay more than the 40% higher rate on earnings between £100,000 and £125,140, there are some things you can do to reduce the risk of being pushed into this tax trap.

For example, if you’re due a bonus at work but the extra earnings would send you into the 60% tax territory, you could ask for a non-cash bonus instead. Many employers often run ‘salary sacrifice’ schemes that allow you to swap some of your salary for tax-free benefits – like a company car, private health insurance, or childcare payments.

Similarly, you could increase your pension contributions
either through a salary sacrifice scheme or by making additional personal contributions. This reduces your taxable earnings below the danger zone, whilst also having the benefit of increasing your retirement funds.

Currently, the maximum for annual pension contributions
that can still receive tax relief is £40,000. However, this only applies if you earn less than £150,000 a year – anything higher will have tapered contributions until £210,000, at which point you can only contribute £10,000 a year with tax relief.

Another way to reduce your income tax liability is to make charitable donations using Gift Aid. This obviously doesn’t have the same personal benefits as contributing to your own pension, but you’ll be giving something back to society and helping to make the world a slightly better place.

Get professional income tax advice

The newspaper articles we mentioned earlier highlighted the fact that since the £100,000 threshold for tapering the Personal Allowance hasn’t changed since 2010, but the Personal Allowance
itself has almost doubled in that time, there is now an income band where £25,140
could be caught out by a 60% tax charge.

The only good piece of news is that you might be able to claim the same rate of tax relief on pension contributions or Gift Aid donations if you are snared by the 60% income tax trap. Tax rules in the UK are updated frequently and are often confusing for many, but one way to make sure you mitigate or avoid tax sinkholes like this is to get professional advice.

Tax consultants like ourselves at GBAC, accountants in Barnsley, are always up to date with the latest tax legislation, and have the necessary expertise to help you evaluate your individual income circumstances and calculate the most efficient tax relief options for you. If you could benefit from our tax planning advice, or need help with a Self-Assessment tax return, be sure to get in touch with our team.