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Tax Calculation - Earned/Unearned Income
Zebra
Posts: 6,702 Forumite
in Cutting tax
I'm hoping someone will be able to comment on the following scenarios.
Scenario 1:
Mrs White has a salary of £25,000 plus rental income of £13,000 plus untaxed interest of £11,400, giving a taxable income of £49,400.
She therefore pays £8,960 in income tax. (£11,000 x 0% + £32,000 x 20% + £6,400 x 40%)
She pays £8,000 into her pension scheme and receives £2,000 in basic rate tax relief.
She isn't eligible for higher rate tax relief as her earned income of £25,000 is less than the threshold.
Therefore Mrs White ends up with £10,000 in her pension pot, a net tax bill of £6,960 and a balance of £32,440 from her original £49,400.
Scenario 2:
Dr Black has the same salary of £25,000 as Mrs White and the same rental income of £13,000 and untaxed interest of £11,400.
However Dr Black pays £10,000 into his pension by way of deduction from his gross salary.
Giving him a taxable income of £39,400 on which he pays tax of £5,680. (£11,000 x 0% + £28,400 x 20%).
Therefore Dr Black ends up with £10,000 in his pension pot, a tax bill of £5,680 and a balance of £33,720 from his original £49,400.
Is Dr Black missing something before he gets clobbered from behind?
Scenario 1:
Mrs White has a salary of £25,000 plus rental income of £13,000 plus untaxed interest of £11,400, giving a taxable income of £49,400.
She therefore pays £8,960 in income tax. (£11,000 x 0% + £32,000 x 20% + £6,400 x 40%)
She pays £8,000 into her pension scheme and receives £2,000 in basic rate tax relief.
She isn't eligible for higher rate tax relief as her earned income of £25,000 is less than the threshold.
Therefore Mrs White ends up with £10,000 in her pension pot, a net tax bill of £6,960 and a balance of £32,440 from her original £49,400.
Scenario 2:
Dr Black has the same salary of £25,000 as Mrs White and the same rental income of £13,000 and untaxed interest of £11,400.
However Dr Black pays £10,000 into his pension by way of deduction from his gross salary.
Giving him a taxable income of £39,400 on which he pays tax of £5,680. (£11,000 x 0% + £28,400 x 20%).
Therefore Dr Black ends up with £10,000 in his pension pot, a tax bill of £5,680 and a balance of £33,720 from his original £49,400.
Is Dr Black missing something before he gets clobbered from behind?
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Comments
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I'm hoping someone will be able to comment on the following scenarios.
Scenario 1:
Mrs White has a salary of £25,000 plus rental income of £13,000 plus untaxed interest of £11,400, giving a taxable income of £49,400.
She therefore pays £8,960 in income tax. (£11,000 x 0% + £32,000 x 20% + £6,400 x 40%)
Almost correct - you haven't allowed for for the £1000/£500/£0 0% tax band on interest. If I've understood other posts on here that means it's £8,860 in income tax. (£11,000 x 0% + £500 x 0% + £31,500 x 20% + £6,400 x 40%)
Err, no. She pays £8000 into her pension scheme and her pension scheme receives an extra £2,000 in basic rate tax relief. Therefore Mrs White ends up with £10,000 in her pension pot.She pays £8,000 into her pension scheme and receives £2,000 in basic rate tax relief.
She isn't eligible for higher rate tax relief as her earned income of £25,000 is less than the threshold.
Therefore Mrs White ends up with £10,000 in her pension pot, a net tax bill of £6,960 and a balance of £32,440 from her original £49,400.
But, HMRC extend her basic rate tax band by the gross amount of the pension payment, so this increases from £32000 to £42000. Also, I think that since her gross adjusted income is now less than her HRT tax band, then her 0% interest band increases from £500 to £1000. So her new income tax payable becomes £7,480. (£11,000 x 0% + £1000 x 0% + £37,400 x 20%)
Therefore Mrs White ends up with £8,000 (+£2000 from HMRC) in her pension pot, a tax bill of £7,480 and a balance of £33,920 from her original £49,400.
Again, you've forgotten the 0% interest band, which will be £1000 for a basic rate tax payer. So...Scenario 2:
Dr Black has the same salary of £25,000 as Mrs White and the same rental income of £13,000 and untaxed interest of £11,400.
However Dr Black pays £10,000 into his pension by way of deduction from his gross salary.
Giving him a taxable income of £39,400 on which he pays tax of £5,680. (£11,000 x 0% + £28,400 x 20%).
Therefore Dr Black ends up with £10,000 in his pension pot, a tax bill of £5,680 and a balance of £33,720 from his original £49,400.
he pays tax of £5,480. (£11,000 x 0% + £1000 x 0% + £27,400 x 20%).
Therefore Dr Black ends up with £10,000 in his pension pot (+ £0 from HMRC), a tax bill of £5,480 and a balance of £33,920 from his original £49,400.
So both scanarios work out the same in income tax and pension terms.Is Dr Black missing something before he gets clobbered from behind?
No but Mrs White is. She will be paying NI at a rate of 12%/2% on her salary so won't get as much in her bank account as Dr Black.
I think.0 -
Almost correct - you haven't allowed for for the £1000/£500/£0 0% tax band on interest. If I've understood other posts on here that means it's £8,860 in income tax. (£11,000 x 0% + £500 x 0% + £31,500 x 20% + £6,400 x 40%)
I get it to just £8,760, so another £100 less. Total £49,400 less £11k pa, less £500 interest allowance gives taxable income £37,900, £32,000 at 20% and £5,900 at 40%.
But it changes when the pension contribution is factored in. The £8000 pension extends the basic rate band so that none of the income is taxable at higher rate, so the £8760 tax is reduced to £7480. The full £1000 personal savings allowance is available due to total taxable income being under the h/r threshold.
Husband's position works out exactly the same. The only difference is that a lower gross salary means lower employees national insurance, so he will save a bit there and so his "net" after tax/nic will be a little higher than Mrs. But that's due to NIC, not tax. It also depends how his employer deals with the £10k - if they reduce his gross salary before it hits his payslips, he'll pay less NIC, but if they show his gross unchanged and add a deduction line on the payslips, it may only affect tax and leave his NIC based on the higher salary, so he may not benefit from the lower NIC.0 -
I get it to just £8,760, so another £100 less. Total £49,400 less £11k pa, less £500 interest allowance gives taxable income £37,900, £32,000 at 20% and £5,900 at 40%.
As I understand it, the new interest allowances reduce the basic rate band, as per Judwin's original calculation. May be wrong though, HMRC is not exactly making it easy to see what they intended!0 -
I get it to just £8,760, so another £100 less. Total £49,400 less £11k pa, less £500 interest allowance gives taxable income £37,900, £32,000 at 20% and £5,900 at 40%.
I think that's the point of the discussions in other threads. The £32K 20% band gets is reduced by the amount of the 0% interest PSA band. So the point at which HRT is payable remains at £43K. You don't get £11K PA + £32K BRT + £1K PSA. You get £11K PA + (£32K - PSA) BRT + £0/£500/£1000 PSA.
It gets even more important if some of the unearned income were to be dividends. The new £5K 0% dividend band also appears to be a band within/subtracted from the £32K BRT.
So lets take Miss Scarlet, who has a salary of £25K, Building Society interest of £2K and Dividend income from shares held outside an ISA of £22400, giving her a taxable income of £49,400. With no pension payments, she is entitled to a £500 PSA, and £5000 Divvy allowance, so her BRT income band gets reduced to (£32000-£500-£5000) = £26.5K.
Her tax due is therefore :
Salary : £11K @ 0% = £0, £14K @ 20% = £2800
BSI : £500 @ 0% = £0, £1000 @ 20% = £200, £500 @ 40% = £200
DIV : £5000 @ 0% = £0, £17400 @ 32.5% = £5655
Total tax due = £8855.
Now suppose she makes a £8K net payment into a pension plan, and HMRC gross this up to £10K. Her BRT tax band gets extended by this £10K from £32K to £42K. Since her adjusted income (£49.4K) is now less than her HRT band (£11K + £42K) she gets the full £1K PSA, so her tax calc becomes
Salary : £11K @ 0% = £0, £14K @ 20% = £2800
BSI : £1000 @ 0% = £0, £1000 @ 20% = £200
DIV : £5000 @ 0% = £0, £17400 @ 7.5% = £1305
Total tax due = £4385
Therefore Miss Scarlet ends up with £8,000 (+£2000 from HMRC) in her pension pot, a tax bill of £4385 and a balance of £37,015 from her original £49,400.
I think there are going to be a lot of small business owners caught out by this - people who get 'paid' in both dividends and salary.Husband's position works out exactly the same. The only difference is that a lower gross salary means lower employees national insurance, so he will save a bit there and so his "net" after tax/nic will be a little higher than Mrs. But that's due to NIC, not tax. It also depends how his employer deals with the £10k - if they reduce his gross salary before it hits his payslips, he'll pay less NIC, but if they show his gross unchanged and add a deduction line on the payslips, it may only affect tax and leave his NIC based on the higher salary, so he may not benefit from the lower NIC.
Yes, but on a £10K (gross) pension contribution from income within the BRT band, the employee will be paying 12% NI, so that means they get £1200 less in their pay packet per year over someone doing salary sacrifice. That's £100 per month.
I think?0 -
Thanks Judwin.
Do you have any links as to why you believe that to be the case?But, HMRC extend her basic rate tax band by the gross amount of the pension payment, so this increases from £32000 to £42000.
As I understand it, unearned income such as rental income and interest payments isn't eligible for tax relief.0 -
Do you have any links as to why you believe that to be the case?
.
No links, but I do have my past 20 odd years Self Assessment Tax Calculation letters from HMRC to me. My tax affairs aren't much different to Miss Scarlett's, but you'll have to forgive me for not posting a scan of the whole thing. Anyway, in the middle of the 2014-2015 statement it states...HMRC wrote:How I have worked out your Income Tax
Your basic rate limit has been increased by £21000 to £53565 for pension payments etc
This reduces the amount of income charged to higher rates of tax.
I made £21000 gross payments into my pensions last year. So all income (Salary, Dividends, Interest etc.) gets tax relief for personal pension payments.
However, you may be getting confused with what constitutes "relevant earnings". In any tax year, you can only pay into a PP a total amount up to your "relevant earnings" or £40K, whichever is lower. "Relevant earnings" includes salary and any benefit's in kind (stuff on your P11D), but excludes interest and dividends.
This means that our three murder suspects (Dr Black, Mrs White and Miss Scarlett) can only pay a maximum of £25K gross into their PP's because that's their declared "Relevant Earnings".0 -
Do you have any links as to why you believe that to be the case?
Have a read of this, it explains the relevance of earned income to decide the maximum contributions allowable and also explains the increasing of the basic rate band for 40% + tax payers:
http://www.pruadviser.co.uk/content/knowledge/technical-centre/tax_relief_members_contributions/#40 -
No links, but I do have my past 20 odd years Self Assessment Tax Calculation letters from HMRC to me. My tax affairs aren't much different to Miss Scarlett's, but you'll have to forgive me for not posting a scan of the whole thing. Anyway, in the middle of the 2014-2015 statement it states...
I made £21000 gross payments into my pensions last year. So all income (Salary, Dividends, Interest etc.) gets tax relief for personal pension payments.
However, you may be getting confused with what constitutes "relevant earnings". In any tax year, you can only pay into a PP a total amount up to your "relevant earnings" or £40K, whichever is lower. "Relevant earnings" includes salary and any benefit's in kind (stuff on your P11D), but excludes interest and dividends.
This means that our three murder suspects (Dr Black, Mrs White and Miss Scarlett) can only pay a maximum of £25K gross into their PP's because that's their declared "Relevant Earnings".
You are absolutely correct and the the confusion between the extension of the basic rate band and relevant earnings is commonplace.
I am, however, most upset at your suggestion that Dr. Black is a suspect in his own murder! Most unfair.:rotfl:0 -
Almost correct - you haven't allowed for for the £1000/£500/£0 0% tax band on interest. If I've understood other posts on here that means it's £8,860 in income tax. (£11,000 x 0% + £500 x 0% + £31,500 x 20% + £6,400 x 40%)
Err, no. She pays £8000 into her pension scheme and her pension scheme receives an extra £2,000 in basic rate tax relief. Therefore Mrs White ends up with £10,000 in her pension pot.
But, HMRC extend her basic rate tax band by the gross amount of the pension payment, so this increases from £32000 to £42000. Also, I think that since her gross adjusted income is now less than her HRT tax band, then her 0% interest band increases from £500 to £1000. So her new income tax payable becomes £7,480. (£11,000 x 0% + £1000 x 0% + £37,400 x 20%)
Therefore Mrs White ends up with £8,000 (+£2000 from HMRC) in her pension pot, a tax bill of £7,480 and a balance of £33,920 from her original £49,400.
Have I misunderstoood something?
Let's see what happens if Mrs White has £50K of earned income only and pays £5K gross into her pension.
Tax=£11K x 0 + £32K x 20% + £2K x 40% = £7200 tax
She increases her income by £1K of rent. HMRC raise the basic rate band to £37K
Tax=£11K x 0 + £37K x 20% + £3K x 40%=£8600 tax
So her tax has gone up by more than her increased income!0
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