For every £2 that you now earn above the £100,000 threshold, £1 of your personal allowance is removed. This means that high earners face an additional tax rate of 20 per cent on up to £22,000 of their income.
Keep reading to learn more and to find out how you can avoid this additional tax bill.
52 Ways to Save Tax – Part 24: Don’t earn over £100,000
For every £2 of income that you earn over £100,000 you will lose £1 of your personal allowance. Your personal allowance is zero if your income is £122,000 or above (tax year 2016/17).
If you earn £122,000 you will lose all of your £11,000 personal allowance. £11,000 of your income will then be taxed at 20 per cent and the £22,000 will have been taxed at 40 per cent. It all means that your marginal rate of tax on this portion of your income is a huge 60 per cent.
Dermot Callinan, UK Head of Client Advisory at KPMG, says: “It makes what its otherwise a progressive income tax system regressive.”
As wages go up, more and more taxpayers are falling into this trap. Estimates suggest that more than a million taxpayers will lose some or all of their personal allowance by 2018/2019.
Patricia Mock, a tax director at Deloitte, points out that as the personal allowance has risen since 2010 (from £6,475 to £11,000) the band of income on which this 60 per cent effective rate is paid has widened.
What you can do if you earn just over £100,000
To avoid paying an effective rate of 60 per cent on a small portion of your income, there are some steps you can take.
Firstly, you can top up your pension. By making an increased pension contribution you can reduce your ‘adjusted net income’ to under £100,000. You can use unused annual allowances going back three tax years to increase the amount you wish to contribute if you need to.
Ms Mock from Deloitte adds: “If you fall into the relevant income bracket, then sheltering your income by making a large pension contribution is a very practical way forward.”
Another way that you can reduce your adjusted net income is to make a charitable donation. Charitable donations are deducted from your income and can help you to bring your earnings below the £100,000 threshold.
Both these options will help you to cut your earnings to under £100,000 and you will avoid paying a marginal tax rate of 60 per cent on up to £22,000 of your income.