You may have to pay more income tax if your annual income exceeds £100,000 as a result of the abatement of the annual personal allowance. The allowance is gradually reduced until it is eliminated in full.
The annual personal allowance is:
2018/19 – 11,850
2019/20 – 12,500
2020/21 – 12,500
Once your “adjusted net income” exceeds £100,000 your personal allowance is reduced by £1 for every £2 of income over and above £100,000.
If in 2019/20 you have income of £120,000 and make (gross) pension contributions of £5,000 then your adjusted net income is £115,000.
It’s over the £100,000 limit and so the annual personal allowance is reduced. The £12,500 is reduced by £1 for every £2 by which your income exceeds £100,000.
The reduction in the personal allowance is therefore £7,500 (half of (£115,000 minus £100,000)).
The personal allowance for 2019/20 becomes £5,000.
The 60% tax zone
When your net income falls within the zone in which the personal allowance is reduced (that’s from £100,000 to £125,000) then the marginal rate of tax is 60%. This is the combined effect of the application of the higher rate of tax and the reduction in the personal allowance. Currently for 2019/20 the upper end of the band is £125,000 but that may not be true for other years, the strict upper limit is £100,000 plus twice the personal allowance.
Abatement was introduced on 6 Apr 2010 when the threshold was set at 100,000. Almost every year the annual person allowance goes up and tax rate bands are adjusted. However, the abatement threshold has never changed. This means that over time more people are becoming liable to 60% tax. If your employment or self employment income is over 100,000 then there is National Insurance at 2% as well. Don’t let anybody tell you that the highest rate of tax in the UK is 40%, it’s 62%.
There are three options, none of which is easy:
1. Pay the tax
2. Reduce your income below £100,000
3. Increase your income so much that a mere 60% on a 25,000 tranche of your income pales into insignificance.
Don’t dismiss that last one. All you need is a plan. What does your business plan say?