This week’s Case of the Week isn’t a case, but a nerdy but interesting point on what our chancellor means by the term “simplify”.

On 23 September 2022, the Chancellor announced the 45% Additional Tax rate would be scrapped. One of the reasons given for this was to “simplify” the tax system.

There has been much media coverage about the scrapping of the 45% rate and it has now been reversed, but very little has been said about the disguised 60% tax band that affects lower paid employees than the 45% band.

Employees have a standard tax free personal allowance of £12,570 (before adjustments for underpaid/overpaid tax and benefits in kind). This means no tax is paid on the first £12,570 of earnings. However, for those earning more than £100k per year, £1 of the personal allowance is lost for every £2 earnt above £100k. This has the effect of taxing earnings between £100,000.00 and £125,140 at 60%. The 60% is the 40% higher rate tax paid on earnings between £100,000.00 and £125,140 plus the extra 20% paid because of the tax free personal allowance disappearing. That’s far from simple. That’s so well hidden that PJH Law has met many employees sitting in the £100,000.00 to £125,140.00 earnings bracket who don’t even realise they’re effectively paying 60% tax (plus national insurance) on some of their earnings.

Most of us earning under £100k might think earning over £100k is a nice problem to have and maybe not feel too sorry for those paying 60% tax, but is it fair or simple that those earning over £150k get their tax reduced from 45% to 40% whilst those earning between £100,000.00 and £125,140 still suffer a hidden 60% effective rate of tax? To be fair, those earning over £150k have gone through the 60% band so do get hit by it too, but if one aims to simplify a tax system, why not remove the loss of personal allowance rule and just stick to simple transparent tax bands that everyone can see and understand?

This tax bracket is important to understand when negotiating settlement agreements whether as an employer or employee. The 60% tax rate can even bite an employee earning under £100k when they are given a Settlement Agreement. E.g. Jane earns £80k PA and is given a Settlement agreement to end her employment at the end of February. She’s paid in lieu of 3 months’ notice and given a £50k termination payment, of which only £30k can be tax free. Jane’s taxable earnings for the tax year are now £113.3k made up of £73.3k salary to the end of February (11/12 of £80k)+ £20k PILON plus £20k of the £50k termination payment = £113.3k. That means Jane, despite normally earning £80k per year, will pay 60% tax on £13.3k of her earnings in the year she received the Settlement Agreement payment, despite at first glance appearing to be only a 40% tax payer because she earns under £150k. Ouch!!! PJH Law could have advised on a couple of strategies to structure the Settlement Agreement in this example to lawfully avoid this 60% tax rate completely and save a four figure sum of tax.