Tax traps – how can I avoid them?

Don’t get caught out by the the tax traps

Most of us know that income tax is generally charged at three main rates: 20%, 40% and 45%. But watch out, as there can also be tax traps which can really bite and result in an effective tax rate of 60%.

Unfortunately, there are certain levels of income that trigger a loss of benefits or allowances as well as a charge to income tax. Because of this, the percentage rate of tax charged can be much higher than the underlying rate of income tax.

Here’s just one example:-

Joe’s taxable earnings have always been under £100,000, however, for this tax year he estimates that his income will be £125,140.

Bad news…

As soon as income for tax purposes exceeds £100,000 Joe loses part of his tax personal allowance (£12,570 for 2024-25).

In fact, for every £2 that his income exceeds £100,000 he will lose £1 of this allowance.

This means that as soon as income is equal to or higher than £125,140 all of the personal tax allowance is no longer available.

Taking this into account, Joe’s tax bill on the top £25,140 of his income is 40% (£10,056) plus, 40% of the lost allowance – a further £5,028.

In total, Joe retains just £10,056 of his £25,140 income (£25,140 – £10,056 – £5,028). His percentage tax charge is therefore 60% on this marginal band of income between £100,000 and £125,140.

Similarly, marginal rates apply if:-

• Your income moves above the threshold where working tax or child tax credits cease to be available – you become a victim of the dreaded HICBC (High Income Child Benefit Charge).
• A higher paid parent’s income tops £60,000 for the first time, at which point child benefits would be under threat
• Your Threshold Income is in excess of £200,000 and you are paying income tax at 45% as you will find the tax relief you can claim for pension contributions may well be reduced.

To avoid or lessen the impact of these marginal rate charges you will need to discuss the possibility of reducing your income below the trigger points.

There are various strategies that can be employed to achieve this, including the sacrifice of salary for non-tax benefits such as increased employer pension contributions or longer holidays.

Is it time for you to rethink your remuneration strategy?

If you are concerned that you may be drifting towards these higher marginal rates of income tax, now is the perfect time to reconsider the way you structure your remuneration package.

Please call us here at THP Chartered Accountants today if you would like our help to do this, with offices in  Chelmsford, Sutton, Wanstead and Saffron Walden.