A simple, visual model of 2016/17

talexuser

It looks like someone at the Telegraph has read this thread:
http://www.telegraph.co.uk/tax/income-tax/hmrc-struggles-cope-tax-changes-hope-rest-us/

However explaining exactly what the problem is also beyond them :rotfl:

kidmugsy

It's been a long time since I thought about this sort of thing, but could this allocation problem be modelled as a Linear Programming problem, with the objective function being the amount of tax to be paid, and the constraints being the allowances? (At least if you excluded the horrors of rental income, and pension contributions subject to tapering, and anything else that is independently nastily intricate. And pension contributions and withdrawal of Personal Allowance, and child benefit, and .....)

Or would the objective function turn out to be piecewise linear or otherwise objectionable? But even then, even if it turned out to be an NLP problem, surely it would be a doddle to solve? For most people there just aren't many variables, are there? x1 = earned income + pension income, x2 = dividend income, x3 = savings income. A three-variable problem, but you could perhaps reduce it to a two variable problem by incorporating total income as a given constant, TOT, and replacing x1 by TOT - x2 - x3.


If it is (for most people) a two-variable problem you could solve it graphically.

Hm. On second thoughts it's probably a bit too intricate for a graphical solution to be elegant, and maybe using all three variables makes sense; but still, just writing it down as an optimisation problem ought to bring clarity.

Come to think of it, writing it down as an optimisation problem, and including all the nastily intricate points mentioned above, would mainly just reveal what an appalling pig's breakfast our income tax system has become.

There must be a good final year undergraduate research project in this.

grey_gym_sock

SnowMan wrote: »

But you have to change the visualisation to allow for the complications of choosing how you allocate earnings, savings and dividends against the personal allowance in the most favourable way or at least in away that comes close to optimising the tax, at which point the next tweek should be obvious.

It's like you've got two filing cabinets. One is the height of your personal allowance and the other is the height of your total income above your personal allowance. The second cabinet is also divided at two points the top of the savings band and the top of the higher rate band, and some coloured drawers are better placed above or below the 2 lines.

Each filing cabinet can be filled with red, blue or green drawers. The different colours represent the different sources of income earnings, savings, dividends respectively.

You are trying to fill the 2 cabinets with drawers subject to an optimisation exercise based on different colour drawers being better placed at different heights.

All same coloured drawers must be next to each other in each cabinet. The green drawers must be at the top and the red drawers at the bottom.

However you can choose how many red, blue or green drawers you place in each cabinet.

hmmm, IMHO the personal allowance is a bin, not a filing cabinet, because there's no right or wrong order for the drawers you put inside it. the order of taxation only applies to whatever you don't put in the bin.

more trivially, i'd rather swap the colours red and blue round, because red is the colour of debt.

on these lines, i've tried to adapt/plagiarize polymaff's model, using a bin and column. this will follow in a separate post.

to keep the model from becoming horrifically complicated, i've moved 1 decision into a separate appendix - viz. how many green bricks to throw in the bin (= how much of the personal allowance is applied against dividend income).

i've written an attempt at the appendix, but i'm at all not confident it's correct yet, so will probably delay posting it. (it is longer than the rest of the model put together. and it's just a lot of simple arithmetic, not a visual thing at all.)

grey_gym_sock

this is my rearrangement of polymaff's model (pushing 1 complicated calculation into a separate appendix, which will follow at a later date) ...

Imagine you have 1 brick for each pound of your taxable income. Green bricks for any dividend income, red bricks for any taxable savings income, and blue bricks for any other taxable income (e.g. earnings, pensions).

Now, prepare to throw as many bricks as will fit into a bin, which has a capacity of 11,000 bricks. Except that:-

*If you donate a Marriage Allowance Transfer, the bin's capacity is reduced by 1,100 bricks. N.B. if you're the recipient of a MAT, there is no change here.

*If you have in excess of 100,000 bricks, then the bin's capacity is reduced by half of the excess, with the qualification that it cannot go below 0.

When throwing bricks into the bin, if you cannot fit in all your bricks, and you have bricks of more than one colour, then:-

*To determine the exact number of green bricks to throw in, see the separate Appendix.

*If you are not completely filling the bin with green bricks, then you should always prefer to throw in blue bricks in preference to red bricks.

When you have completely filled the bin, form your remaining bricks into a vertical column. The top part of the column is any remaining green bricks, the middle part is any remaining red bricks, and the bottom part is any remaining blue bricks.

Now, draw lines across the column at the 5,000 and 32,000 levels. Except that:-

*If you make qualifying pension and/or charitable contributions, raise the 32,000 line by that amount.

The following statements apply, in the order given:-

* Anything in the bin is taxed at 0%.

* Any taxable savings income below the 5,000 line is taxed at 0%.

* If the total column exceeds the 32,000 line then up to a further 500 of taxable savings income is taxed at 0%. If the column doesn't exceed the 32,000 line then make that 500 of taxable savings income 1,000.

* The first 5,000 of dividend income in the column is taxed at 0%.

What is left is taxable - below the 32,000 line at the applicable basic rate, above at the applicable higher rate.

dales1

grey_gym_sock wrote: »

* If the total column exceeds the 32,000 line then up to a further 500 of taxable savings income is taxed at 0%. If the column doesn't exceed the 32,000 line then make that 500 of taxable savings income 1,000.

Personally, I would turn this sentence around. It has already confused a few people, because MOST people's cases are dealt with LAST under this terminology.
I would say - If the column doesn't exceed 32k, then up to 1,000 is at 0 %. Otherwise...

Dales

grey_gym_sock

a slight change of tack ...

polymaff wrote: »

WARNING: The results you get from the above will, in certain circumstances, not match those resulting from your submitting an online self-assessment via HMRC. This is because, by their own admission, and after over 20 attempts, HMRC's own software does not correctly address certain scenarios, the most serious of which is "Non-savings income of less than the Personal Allowance (PA) & Savings Starting Rate (SSR) plus savings income not covered by the Personal Savings Allowance (PSA)". They suggest that you make a paper return as their current timescale for addressing this and other bugs in their own software is: "Planned fix for 17/18".

a practical point with this: how is making a paper return supposed to make this work? don't they just read the paper return into the appropriate computer system, after which the data is treated in exactly the same way as data submitted online (via HMRC's site, or via third-party software)?

is the point that there is a box in the full paper return in which you can (optionally) enter the amount of tax you owe (instead of just letting HMRC calculate it)? but surely they won't just accept any figure you enter there.

or is the point that you should explicitly submit an election (perhaps in the additional information box) for how you want your personal allowance allocated against different kinds of income?

how on earth is this supposed to work? have HMRC said anything about this?

Richard_1963

Many thanks for the information provided as I'm struggling to sort out my lowest tax bill for 2016/17.

I've used the HMRC website and a software package from Andica and both default to (i) employment (ii) savings (iii) dividends for use of allowances. By my reckoning using the dividends allowance first would reduce the tax bill. Andica won't allow any alternative or overwriting and it seems from this thread that HMRC would advise a paper submission.

Is there a software package that advises the optimal use of allowances?

Dazed_and_confused

Richard 1963

This may just be the way you've worded this but you could have misunderstood something here,

By my reckoning using the dividends allowance first would reduce the tax bill.

The "dividend allowance" doesn't really exist, it's actually a 0% rate band which you cannot, as far as I'm aware choose how to allocate.

The allowance referred to in this thread is the Personal Allowance, once that is used the 9 different rate bands applicable to 2016:17 come into play and have a specific order which is basically non savings income followed by savings interest and finally dividends.

As far as i know calculating this is (currently) a manual process to play around and get the best result. If you can provide the income details there's a few on here who will have a bash at the best outcome

Richard_1963

Dazed and confused (very apt)

I did really mean use of the personal allowance and the basic rate. Round numbers

Employment £17,000
Savings Interest £12,000
Dividends £90,000
Total = £119,000
Personal allowance reduced from £11,000 to £1,500
Basic Rate = £32,000

HMRC and Andica calculate tax due as
Employment £15,500 @ 20% = £3,100
Savings £500 @ 0% + £11,500 @ 20% = £2,300
Dividends £5,000 @ 0% + £5,000 @ 7.5% + £80,000 @ 32.5% = £26,373
Total tax = £31,775

Alternative
Dividends £5,000 @ 0% + £32,000 @ 7.5% + £53,000 @ 32.5% = £19,625
Employment £0 @ 20% + £15,500 @ 40% = £6,200
Savings £500 @ 0% + £11,500 @ 40% = £4,600
Total tax = £30,415

Is the alternative a valid method and, if so, how do you ensure HMRC use this method?

Any comments gratefully received

Dazed_and_confused

Ok, my stab at this is we have £117,500 which needs to be taxed after the small amount of personal a allowance due is allocated against the a employment income and the traditional calculation would be

£15,500 x 20% = £3100 (employment)
£500 x 0% = £0 (personal savings allowance)
£11500 x 20% = £2300 (balance of savings income)
£5000 x 0% = £0 (dividend allowance)

That has now used up all of your basic rate band (PSA and dividends allowance use this a up if within the standard basic rate band) and the remaining dividends are all then taxable at the dividend higher rate
£85,000 x 32.5% = £27,625

Total due is 3100 + 0 + 2300 + 0 + 27625 = £33025

Now to have a think about the potential alternative for 2016:17!!