Although the official top rate of UK income tax is currently 50% (with a planned reduction to 45% from APRIL 2013) certain situations can result in much higher marginal tax rates being suffered.
There are a number of traps surrounding personal allowances and child benefit which lie in wait for unwary taxpayers that are identified below.
1. Personal Allowance Trap
The basic personal allowance for the 2012/13 tax year is £ 8,105 but this gradually reduces to NIL where an individual's income exceeds £ 100,000. The allowance is reduced by £ 1 for every £ 2 that a taxpayer's income exceeds £ 100,000 until it reaches £ 116,210 ~ at which stage the personal allowance is withdrawn completely! Therefore because taxpayers are effectively being taxed on one and half times the actual amount of income received above £ 100,000, the normal rate of 40% effectively increases to 60%. Factor in national insurance contributions and this rises to a breathtaking 62%.
2. Loss of Age Allowance
Taxpayers aged between 65 and 74 are normally entitled to an age-related allowance of £ 10,500 for 2012/13. However, where a person's taxable income exceeds £ 25,400 their allowance is gradually reduced by £ 1 for every £ 2 of income above £ 25,400 until the normal personal allowance of £ 8,105 is reached. This means that although an individual over 65 with income of say £ 30,000 should only be liable at the 20% basic tax rate, the income above £ 25,400 is effectively taxed at 30%.
It should be noted that the age-related allowance is to be phased out over the next few years as part of the Government's plan to simplify the tax system. In due course there will be a single personal allowance for taxpayers of all ages, resulting in the tax affairs of many individuals over 65 being much less complicated.
3. Loss of Child Benefit
From January 2013, child benefit claimants with income between £ 50,000 and £ 60,000 will see their benefit being clawed-back by 1% for every £ 100 that their income exceeds £ 50,000. For example, a married couple with three children where the highest earner receives £ 58,000 of income will find that their child benefit for a complete year will reduce from £ 2,449 to £ 490. Therefore the £ 1,959 loss of child benefit will result in an overall marginal tax rate on the £ 8,000 income of 66.5%!