Do you want to phone a friend?

31 March 2022

Picture Rishi Sunak as a game show host.  The spotlight is on the contestant, an employee, and Rishi asks them if they would like to:

  1. Keep their pay rise;
  2. give it all to the government; or
  3. give it all to charity.

I expect many of us would say “Keep it please!” but, in certain situations, without some action on the employee’s part the default answer is that none of it is kept and the government enjoys it all.

This post briefly discusses one such issue, and offers other suggestions for the tax year end (which are, unfortunately, unlikely to make you a millionaire).

What’s the issue?


Our tax system is complicated. Few people would disagree with this. Underneath the complexity however, you would hope the system is fair, progressive and rational. Unfortunately, that isn’t always the case.

Say you are a successful employee with two young children. You are earning £100,000 and receive a £10,000 pay rise. You should be ecstatic, shouldn’t you?

Surprisingly, you shouldn’t. That pay rise will actually result in less money in your pocket.  Why?

The effective rate of income tax on earnings between £100,000 and £125,140 (tax year 2021-22) is incredibly high. You effectively pay 60% income tax (due to the loss of personal allowance by £1 for every £2 earned over £100,000, combined with a 40% income tax rate).

You have already realised that you will take home £4,000 of your £10,000 pay rise, but you have not thought about your Tax Free Childcare. The moment your earnings tip over £100,000, you lose 100% of this which, as you have two children, is worth up to £4,000. Your £10,000 pay rise has suddenly reduced to zero. Your marginal tax rate for an additional £1 of income over £100,000 is a staggering 400,000%. 

Just to make things even worse, you haven’t yet factored in the additional National Insurance cost of your pay rise (£325, including the new levy to be introduced in 2022).  Whilst this does not take into account the value to you of any other benefits as a result of the salary increase such as any increased employer pension contribution or an increased death in service benefit award, you would be better off refusing the pay rise if you look simply at the cash in your bank account each pay day, which is obviously counter-intuitive. Such a cliff edge does not seem fair or rational although it is arguably very progressive.

A possible solution would be to taper the loss of Tax Free Childcare, or move the threshold up or down so that it doesn’t coincide with the loss of personal allowance. That seems unlikely for the time being so is there anything you can do?

Solutions?
 

  1. Pension contributions
    This is a common solution. You could pay £10,000 into your pension.  If you contribute £8,000, the grossed up deductible amount of £10,000 should bring you back to the £100,000 threshold for the loss of Tax Free Childcare and the personal allowance.  Higher rate tax relief is also available to claim. This contribution reverses the loss of the personal allowance as well as the loss of the Tax Free Childcare, whilst ensuring a nice top up to your pension.   However, the sting in the tail is that you have to make sure you do not exceed your annual allowance for pension contributions because you will otherwise be subject to yet another tax charge. If you can contribute £10,000 via salary sacrifice you will escape the NIC cost of your pay rise.
  2. Gift Aid
    If you are happy to share the cash, but would rather donate to someone other than the government or your pension you could gift your pay rise to a charity instead. Again, a gift of £8,000 to a charity would be treated as a £10,000 gift and so your salary would be reduced to £100,000. You would also benefit from higher rate tax relief too.

Neither of these suggestions is aggressive tax planning, and they both help to avoid the arbitrary £100,000 cliff edge.

Year-end suggestions

More generally, as the tax year draws to a close, below are eight tips (all using available exemptions and reliefs in our tax legislation) to ensure you are being tax efficient:

  1. Top up your ISA to make use of the £20,000 annual allowance and hopefully take advantage of some tax-free growth;
  2. Top up your pension contributions where possible. If not done through salary sacrifice, make sure to claim any higher or additional rate relief in your tax return;
  3. If you are planning on selling any shares, consider selling some in 21/22 and some in 22/23 to take advantage of multiple CGT annual exemptions (£12,300 for both 21/22 and 22/23);
  4. Don’t forget that you can transfer 10% of your personal allowance (essentially if you don’t use it yourself) to a husband or wife or civil partner who earns more than the allowance and pays tax at the basic rate. This could save £252 in 21/22 and you may be able to claim a rebate for several years if never claimed. Even at today’s prices, that is hopefully a few tanks of petrol;
  5. Claim all tax reliefs for working at home. Again, the standard weekly relief of £6 is not huge, but we all know the slogan of the UK’s largest supermarket;
  6. Donate to charity or invest in EIS / SEIS shares if you want to reduce your income tax bill;
  7. If you own a company, consider taking dividends in 21/22 before the dividend rates increase next year (but factor into your decision your marginal rate of tax as well); and
  8. If appropriate, make use of the annual exemption from inheritance tax of £3,000.

FURTHER INFORMATION

For further information on issues raised within this blog, please contact Matt Spencer or a member of our Corporate, Commercial & Finance team.

 

ABOUT THE AUTHOR

Matt Spencer is a partner within the Corporate and Commercial team, specialising in tax law, advising on and efficiently structuring a wide range of corporate and real estate transactions including M&A, land transfers, developments and leases.He is also expert in employment tax issues and the structuring of employee incentive schemes as well as VAT issues in the public and private sector. 

 

 

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We welcome views and opinions about the issues raised in this blog. Should you require specific advice in relation to personal circumstances, please use the form on the contact page.

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