For the tax year 2016-17, most taxpayers are entitled to claim a tax-free personal allowance of £11,000 from their taxable income. The maximum income that can be taxed at the basic rate of 20%, after the personal allowance has been deducted, is £32,000.
Accordingly, if your total income is £43,000 or below you will only pay Income Tax at the basic rate. Any income earned in excess of £43,000 will therefore be taxed at higher rates: 40% or 45%, unless the £43,000 has been increased.
For 2016-17, the higher rate (40%) Income Tax band is £118,000. Income taxable in excess of £150,000 (£43,000 plus £118,000 less the £11,000 personal allowance) will be taxed at the additional (45%) Income Tax rate.
How can you increase your Income Tax bands?
The most common way is to make personal pension contributions or charitable donations under the gift aid regulations. You will get no basic rate Income Tax relief for charitable donations as the payment you have made to the charity is deemed to be the amount of the gift after basic rate tax has been deducted. However, your higher rate (40% and 45%) Income Tax liabilities will be reduced as the basic rate and higher rate Income Tax bands will be increased by the gross gift aid payments you have made: “gross” means the amount before the basic rate tax is deducted. If you make a gift aid contribution of £100, the gross payment is £125 (100/80 x100).
Pension contributions – paid net of basic rate tax relief – have a similar effect, but there are limits on the amount of contributions that can be paid. Advice should be sought before considering this option.
These options for tax planning are especially beneficial for tax payers with annual income between £100,000 and £122,000; as the Income Tax personal allowance is gradually reduced for taxpayers in this income band the effective rate of tax chargeable is 60% on the gross income equivalent.