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T82 - The 50% Rate….are the rumours true??

(This article appeared in "Dentistry" in April 2010) 

I heard a rumour the other day that Income Tax Returns are going to be made simpler. It will consist of only three questions apparently: (1) How much did you make last year? (2) How much have you got left? (3) Send amount listed in part 2.

 Thankfully, that one’s not true, but the one about the 50% rate of tax is.

 Labelled “the additional rate” is will see that part of taxable income over £150,000 being taxed at 50%. There are some things that can be done, legitimately, to avoid it, but one should remember that it may only be a short term measure, so drastic action may best be avoided.

 The ideas we focus on in this article relate to tax planning where a spouse/civil partner assists a self employed individual in his/her business, so all you singles out there can either read on to see what you are missing, turn the page now, or go out and get married.

 Your spouse can be paid a salary for the work they do. Perhaps they help in the practice, or help with your paperwork (therefore being in a very trusted position and perhaps warranting slightly higher pay). They should not be paid any more than an “arm’s-length” individual doing the same work for the same period of time with the same skills. Account can be taken of help provided at unsociable hours and also involving confidential matters that need to be looked after by a trusted individual. So long as you are not paying them more than the market rate, you will get tax relief on what you pay your spouse. This then reduces the profits chargeable to tax on the sole trader. It may also be possible to make pension contributions in respect of the income earned by the spouse.

 Let’s look at a simple example – Mork and Mindy (I wonder how many people remember them?!) Mork is a self employed dentist and Mindy is his wife who helps him in his business. She has no other income and Mork has taxable income over £150,000  

Assuming that the same National Insurance limits as 2009/2010 will apply in 2010/2011, Mork could pay Mindy £5,715 per annum, saving himself £2,858. In addition, Mork would have saved £57 of class 4 National Insurance.

 Mork could also make pension contributions, as an employer, for his new member of staff’s pension scheme  – up to her salary – so £5,715, saving another lot of £2,858 and £57, and with no National Insurance cost as there is no NI on pension contributions.

 Remember, you can spend up to £150 per head per annum on staff parties so that would be £150 – so another saving of £75 and class 4 of £15.

 Total Savings in this case - £5,919 – not bad!

 In many cases, where the spouse is helping substantially, it may be tax efficient to pay more than £5,715. It should be remembered in this case however, that there will be employers NI to pay at 12.8% on the part of the pay over £5,715 per year, but this will also get tax relief. The spouse would also have to pay employers NI at 11% between £5,715 and £43,875 and 1% over that. The spouse would also need to pay income tax is the pay exceeds £6,475 – so as you can see, things get slightly more complex. Let’s knock ourselves out with an example:

 Mork’s  taxable pay is £210,000 so he has lost all entitlement to the personal allowance (Previously, you will recall, you got the first £x amount (known as your personal allowance) tax free. For 2010/11, the personal allowance of £6,475 will be subject to an income limit of £100,000. Your personal allowance will be reduced by £1 for every £2 of gross income they have above the income limit so if your taxable income is over £112,950, you will lose it completely!

He therefore pays tax as follows: 

 Total Tax is therefore £82520 and class 4 NIC is £4,714. 

Let’s now assume that he decides to start paying Mindy for additional responsibilities she is taking on – a salary of £20,000. He decides to match it with a pension of £20,000.

 Taxable income                       £210,000

Less Mindy’s salary                £20,000

Less Mindy’s pension             £20,000

Less employers NI                  £1,828 (12.8% of £20,000 - £5,715)

Less Christmas party               £150

New taxable income               £168,022.

 He now pays tax as follows: 

 Total Tax is therefore £61,531 and class 4 NIC is £4,294.

 Total savings are therefore £21,409

 Mindy will of course pay tax and NI on her £20,000 to the tune of NI £1571.35 and income tax £2,705, which reduced the savings by £4,276 to £17,133

 Your specialist dental accountant will be able to help you with planning like this and if they are also a financial planner – will even be able to help you with setting up the pension! 

There are some other things that can be done to avoid falling into the 50% band, but sadly we are out of space so will save those for another day….

  

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