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Income tax trap: 1m UK taxpayers earning £100,000/year likely to lose tax-free personal allowance

Income tax trap: 1m UK taxpayers earning £100,000/year likely to lose tax-free personal allowance

LONDON: More than 1 million UK taxpayers are expected to be caught in an income tax “trap” in less than four years, whereby those earning £100,000 a year lose their tax-free personal allowance and face a marginal rate of 60 per cent.

Under the coalition government, the number of people affected by this quirk in the tax system has risen by a third, from 588,000 in 2010-11 to a projected 791,000 in 2014-15, official figures show. If this trend continues, they will swell to 1.06m by 2018-19.

High quality global journalism requires investment. The situation arises because the tax-free personal allowance currently set at £10,000 tapers off for those with income above £100,000.

Since 2010, for every £2 earned above this threshold, £1 of the allowance is removed, meaning that high earners face an additional tax rate of 20 per cent (the “lower” tax rate) on up to £20,000 of income. This is on top of the “higher” rate of 40 per cent that they must pay above a threshold of £42,385 — for the tax year that has just begun.

Earnings between £100,000 and £120,000, therefore, face a marginal rate of 60 per cent.

“It makes what is otherwise a progressive income tax system regressive,” said Dermot Callinan, UK head of private client advisory at KPMG.

More taxpayers are now paying this 60 per cent rate as a result of the “fiscal drag” that sets wage inflation against the static £100,000 threshold.

Patricia Mock, a tax director at Deloitte, pointed out that as the personal allowance had risen from £6,475 in 2010 so the band of income on which this 60 per cent effective rate was paid had widened. The tax-free allowance is set to rise further — to £11,000 by 2017-18, meaning income between £100,000 and £122,000 will be affected.

Ms Mock said the de facto 60 per cent rate was quite hard to address: “You could have a cliff edge for the personal allowance, but that would arguably be less fair than a taper.”

George Bull, senior tax partner for Baker Tilly, said the anomaly was regarded as “a bit of a trap”, adding: “Politically, there is a sense it’s a price that higher-paid individuals have to pay as part of a fairness agenda.”

Mr Callinan said the issue encouraged people to “look more closely at their personal pensions contributions”.

Taxpayers in this position who put an extra £1,000 into their pension pot, before tax, can do so at a net cost of £400. The removal of the personal allowance also makes it beneficial for bonuses to be paid over more than one tax year, and makes charitable giving attractive. Chas Roy-Chowdhury, head of taxation at the Association of Chartered Certified Accountants, said many people earning just under £100,000 took such measures.

The share of overall income tax paid by higher earners has increased significantly during this parliament.

The total paid by those earning above £100,000 is projected to rise to £63.9bn in 2014-15, according to HM Revenue & Customs, up from £47.3bn in 2010-11.

This represents an increase in their share of total contributions from 31 to 38 per cent.