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Around 750,000 taxpayers face a shock at the end of the month when they are automatically upgraded to the higher rate tax bracket without earning any more money.
Guest Blog provided by Steve Sims, author of “Understanding And Paying Less Property Tax For Dummies”. Steve and his wife also have a boutique accountancy business which specialisis in providing taxation advice and accountancy services for property investors.
The tax switch means taxpayers can earn £1,400 a year less than this tax year but still pay more tax because they come in the higher rate threshold.
For example, taxpayers with a full personal allowance of £6,475 – a tax code of 647L – could earn £43,875 in the 2010-11 tax year before paying income tax at 40% and capital gains tax at 28%.
For the 2011-12 tax year, staring on April 6, this changes. The same taxpayers gain £1,000 on their personal allowances – pushing the maximum to £7,475 or a tax code of 747L.
But they can only earn £42,475 before paying income tax and capital gains tax at the higher rates of 40% and 28%.
This tax change will affect several key areas of financial planning:
Savings – Tax is deducted at 20% on savings accounts, but these new, upgraded higher rate taxpayers will have to pay extra tax through a self-assessment return. Savings are already under severe erosion from inflation, and paying more tax will make the returns even worse.
Dividends – Tax is deducted at 10% on stocks and shares and then a further 32.5% is paid by higher rate tax payers through their tax return.
Rental profits – Rental profits are added in to taxpayer’s other earnings and can nudge many landlords in to the higher rate tax bracket. This is a key year for landlords as many have exhausted previous losses and will start to declare significant property profits.
Capital gains – This is paid on disposal of assets like property, shares and luxury goods, like art, antiques and fine wines. Higher rate taxpayers pay at a rate of 28%, while lower rate taxpayers pay at 18%.
Other rates come in to play for business assets and furnished holiday lets, like entrepreneur’s relief charged at 10%.
One way of saving tax is to run an income-shifting review.
Income shifting is transferring income generating assets between married couples or civil partners.
If the breadwinner is a higher rate taxpayer and the other partner stays at home and has no income, then shifting some assets from one partner to the other makes good financial sense.
For instance, Mr Smith owns several buy to lets generating £10,000 a year in profits. He is a higher rate taxpayer and all the rental profits are taxed at 40%. Mrs Smith works part-time but can earn an extra £12,000 a year before she pays higher rate tax.
Mr Smith pays income tax of £10,000 x 40% = £4,000 on the rental profits.
The Smiths can simply transfer all or some of the rental properties to Mrs Smith.
Mrs Smith would pay income tax of £10,000 x 20% = £2,000 on the rental profits.
Certainly some costs would be incurred in the transfer of title, but in the second and subsequent years, the tax saving would be significant.
Income shifting would also save Mr and Mrs Smith income tax paid on savings and dividends as well.
However, once Mrs Smith’s gross income from all sources reached £42,475, she would pay income tax at the same rate as her husband.
Saving tax by income shifting means a married couple planning their finances can earn up to £84,950 and pay income tax at a rate of 20% or less.
If you need a property business check or help keeping financial records and preparing tax returns, a link to Steve’s web-site can be found HERE.
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