Top tax-trimming tips for 2011
Tax strategies for higher earners
In the current tax year, the following tax rules apply for higher earners:
• Income above £150,000 is taxed at 50%.
• The personal allowance is withdrawn by £1 for every £2 of income above £100,000 so that it runs out completely when income reaches £112,950. As a result, those with incomes between these levels face a marginal tax rate of 60%.
• National Insurance contributions on salaries up to £43,888 are charged at 11% and at 1% above this level.
Next year, the following changes will be made:
• Although the upper threshold for the full rate of National Insurance will fall to £42,484, the rate will rise by one percentage point to 12% and the rate above this level will rise to 2%.
• For the self-employed, the upper profits threshold is similar to that applying to employees' salaries. The £43,875 profits upper limit applying this year will drop to £42,475 next year. However, this year's 8% NIC rate will rise to 9% next year. The rate applying to profits above the upper profits limit will rise from 1 to 2%.
• The tax on dividends for those earning more than £150,000 will be 42.5%.
What can individuals do to minimise the effect of these higher tax rates and NICs?
Of course, you can maximise your pension contributions, which will bring down your taxable income, or hive off income-producing assets into a tax-exempt vehicle by putting more money into ISAs. However, there are less obvious ways of avoiding higher tax rates.
Salary sacrifice involves taking a pay cut and receiving a pension contribution from your employer instead. HMRC will not allow those earning more than £150,000 to do this, but for those earning less, salary sacrifice remains permissible.
It is also attractive for employers, who avoid paying 12.8% (13.8% next year) in NICs.
Salary sacrifice will be especially attractive for those earning between £100,000 and £112,950, as they will avoid a 60% marginal tax rate on their income in that slice, as it can be converted into an employer pension contribution.
Those who run their businesses through a company will be tempted to take profits as a capital gain, as the top rate of income tax of 50% is much higher than the capital gains tax rate of 10% if the gain qualifies as Entrepreneurs' Relief.
Otherwise capital gains are taxed at 18% for basic-rate taxpayers or 28% for higher-rate taxpayers. The CGT annual exemption is £10,100 in this tax year. Gains up to this level are tax-free. But taxpayers must tread carefully. HMRC can apply anti-avoidance rules to prevent the conversion of income into a gain.
The self-employed may want to set up a limited company to work through. There is scope to take income free of NICs, while corporation tax on profits of up to £300,000 is taxed at 21% (20% next year).
Provided certain rules are observed, profits can be retained in the company to avoid higher rates of personal tax. And as rates of personal tax and NICs rise, this approach is likely to become increasingly attractive.
If your income fluctuates, you might be able to change the year in which income is recognised. For example, if your income is around £90,000 this year and there is talk of a £20,000 bonus in the spring, some of this would be taxed at 60%.
However, if the bonus is discretionary, you can reduce your tax liability by delaying the bonus until next year.
The same applies to dividends received from your company. HMRC is likely to scrutinise arrangements that artificially alter the timing of such payments. But if profits are retained in a company, the directors or shareholders can choose when to pay out these profits as a dividend.
Another option is to make use of your spouse or civil partner. If they pay tax at a lower rate than you, you may be able to pay them income or pass them an asset that is then taxed at this lower rate. It may be possible to pay a salary to your spouse from your company, for example, provided you can justify their salary.
It may also be possible to increase pension contributions for a spouse who earns below the £150,000 limit if you are close to the limit yourself.
Split-year Capital Gains Tax opportunities
Capital Gains Tax (CGT) for higher-rate taxpayers was increased this year from 18 to 28%. However, this only applies to gains made after 22 June 2010. As a result, you may need to split a gain in two to calculate the gains in each part of the year.
Entrepreneurial CGT relief, under which CGT is charged at just 10%, was boosted to a higher lifetime limit of £5 million (up from £2 million).
To illustrate how these new rates work in practice, take Paula, who made a capital gain in April 2010 of £20,000 and another gain in August 2010 of £35,000.
She has a total income for the year of £30,000. The personal allowance for 2010-11 is £6,475 and the higher-rate tax threshold is £37,400. Adding these together gives you the total taxable income limit above which the 28% CGT rate would kick in - £43,875.
The pre-23 June gain is taxed at the flat rate of 18%. To calculate the post-22 June gain, Paula needs to compare her income with the higher-rate tax income threshold after taking into account the personal allowance.
As her taxable income is £30,000, after deducting her personal allowance, her income is £23,525, which is lower than the higher-rate tax threshold by £13,875.
As a result, this part of the taxable gain is taxed at 18% and the rest at 28%. But before calculating the taxable gain, Paula can choose which gains will absorb her CGT annual exemption of £10,100.
As she can avoid paying CGT on the post-22 June gain at the higher rate of 28%, she should set the annual exemption against this gain, which brings the taxable post-22 June gain down to £24,900 (£35,000 less £10,100).
The first £13,875 is taxed at 18%, as this uses up the remainder of her basic-rate tax band, and the remaining gain of £11,025 is taxed at the higher rate.
If Paula had losses in the year, she would offset these, like the annual exemption, in a way that minimises her CGT. So in-year losses, whether realised before or after 23 June, as well as losses brought forward from earlier years, should be offset against the post-22 June gains to minimise the gains taxed at 28%.
Note that pre-23 June gains are ignored when comparing the post-22 June gains with the level of income for the year. In future, this split-year complication will not recur. The annual exemption will be deducted from total gains, and the resulting taxable gain will be taxed at 18% or 28%, or at a bit of both, depending on income.
If Paula's income was, say, £50,000, all the post-22 June gains would be taxed at 28% (after deducting the annual exemption and losses).
If you are sitting on losses towards the end of the tax year, it may be worth selling assets and triggering a loss that can then be offset against gains that would otherwise be taxable, especially if these are post-22 June 2010 gains that would otherwise be taxed at 28%.
An alternative way of making use of a loss is to transfer an asset between spouses or civil partners. This can be worthwhile if, for example, a husband has gains while his wife holds an asset that has lost value.
If she transfers the asset to her husband and he sells it, the loss belongs to him and he can use it to reduce his net gains. Transfers between spouses and civil partners take place on a 'no gain, no loss' basis. As such this is a useful way of minimising a couple's overall CGT liability.
Assets can also be transferred between a couple so that income is taxed in the hands of the partner who pays tax at a lower rate.
This article was taken from the February 2011 issue of Money Observer.
A tax-efficient way of receiving staff benefits, where an employee agrees to forego a proportion of their salary for an equivalent contribution into their pension scheme or in exchange for company car, gym membership, childcare vouchers or private medical insurance. A salary sacrifice scheme is a matter of employment law, not tax law, and is often entered by an employee who is about to move into the higher 40% tax bracket.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.