Anyone with an annual income which exceeds £100,000 must file a tax return, even if you were taxed through PAYE. One of the biggest tax implications of earning over £100,000 is that you start losing your Personal Allowance, which is £12,500 for 2020/21 . For every £2 that you earn over £100,000, you lose £1 of your Personal Allowance. Meaning that if you earn more than £125,000 you will be taxed on the first pound of income made.
If someone is a higher earner and earns more than £100,000 then they may be paying tax at a 60%! You will not find this rate listed on the HMRC website, but because the personal tax allowance is withdrawn for income over £100,000, earnings of between £100,000 and £125,000 (20/21) will be taxed at an effective rate of 60%. This can be illustrated by way of the below example.
Let’s assume someone earns £100,000 and receives a commission of £2,000. The normal tax rate for this level of income is 40% and so the tax on the bonus is £800. However, because the commission takes the total income over £100,000 at which point the personal allowance starts to be withdrawn. In this example £1,000 of the allowance will be lost. This means that £1,000 of the normal earnings are now going to be taxed at 40% as they are no longer covered by the allowance. £1,000 at 40% is £400. Accordingly, the £2,000 bonus will cost £1,200 in tax (£800 plus £400) i.e. an effective 60% tax rate.
Ways to avoid falling into the 60% tax trap
- Save more into your pension
When you save into a pension, the government likes to give you a bonus as a way of rewarding you for saving for your future. This comes in the form of tax relief. The government puts a limit on the amount of pension contributions on which you can earn tax relief. This is called the pensions annual allowance, which was set at £40,000 for 2020/21. If you earn under £150,000 a year you can save up to annual allowance of £40,000 and get back the whole amount of tax on it. Your pension provider will help you get back about half of that automatically, and you can get the rest by filing a Self Assessment tax return.
- Take non-cash employee benefits
In case it is your commission or bonus that puts you in the earners category of over £100,000 then it is worth to consider remuneration in an alternative way. By reducing your cash earnings by just a bit, you can push your income below £100,000 – while also getting your bonus. This could be in form of your employer covering your private medical insurance or providing funds for child-care. These are tax-free if you get them through the salary sacrifice scheme.
- Invest in startups
Similarly, as with the pension scheme mentioned above by investing into a qualifying scheme massive tax savings can be achieved. By investing into the Seed Enterprise Investment Scheme (SEIS) 50% of the investment amount (up to £150,000 limit) is eventually shaved of your tax bill. Likewise, by investing into the Enterprise Investment Scheme (EIS) or the Venture Capital Trust (VCT), 30% of the investment amount (up to £1,000,000 limit) will be netted off your tax bill. If you are lucky and held the investment for long enough, the capital gains might be free of tax too.
