Beware of a potential 60% tax rate risk on your bonus. If you receive a bonus this year then it’s possible you will pay an effective 60% tax rate on your additional income. There are ways to mitigate this very high tax rate but you need to act now!
Everyone receives a personal tax allowance – £12,500 for the 2019/20 tax year – but this allowance is reduced by £1 for every £2 your income is over the £100,000 limit in a process known as personal allowance abatement.
If your ‘adjusted net income’ – your total taxable income before any personal allowances, less certain tax reliefs (including trading losses, Gift Aid donations, and pension contributions) is around £100,000 – £119,000 and then you receive a bonus in addition, you could be paying additional tax on the bonus amount as your allowance is progressively reduced.
How the effective 60% tax rate on your bonus is calculated
Let’s look at a couple of examples to see how the effective 60% tax rate is calculated and how you may be impacted.
Megan is an employee and draws a salary of £100,000 per annum with no other sources of income apart from a £7,000 bonus payable at year end.
Because the bonus takes Megan’s income above £100,000, her personal tax allowance is reduced to £9,000. (£12,500 original personal allowance less £3,500).
She will pay £2,800 tax (£7,000 × 40%) on the bonus, plus an extra £1,400 due to the lost allowance (£3,500 × 40%) making the total tax attributable to the bonus £4,200 – an effective rate of 60% (£4,200/£7,000 x 100).
Compare this with Harry who receives an annual salary of £125,000 with no other sources of income apart from a £7,000 bonus at year end. Harry does not receive a personal tax allowance of £12,500 as his basic salary of £125,000 is the point at which the allowance is fully withdrawn. The bonus, therefore, does not impact his tax rate and he will simply pay £2,800 on the bonus: the standard 40% tax rate.
What can be done to minimise exposure to these marginal tax rates?
If your income is slightly over the £100,000 ceiling, you can avoid losing some or all of your personal allowance. This involves reducing your ‘adjusted net income’ to below the abatement threshold. Consider:
- Increasing your pension contributions – for example if your income is £106,000 you could make a pension contribution of £6,000. You’ll receive 40% tax relief on the contribution and your full personal allowance will be reinstated.
- Donate to charity under the Gift Aid scheme. The donation is assumed to be made net of basic rate tax, which the charity claims back from HMRC. Your basic rate tax band is increased by the value of the gross donation, which in turn reduces the amount of income to be taxed at the higher rate.
- Consider transferring income-producing assets to a lower-earning spouse or partner.
Here is a link to HMRC’s Income Tax rates and Personal Allowances page: https://www.gov.uk/income-tax-rates/income-over-100000
Our advice is to always consult with your accountant before taking any action as it’s important to consider the wider picture. Contact Amy our Tax Specialist 01992 444466 or by email at email@example.com and we’ll advise you on the best cause of action for you.