Your tax-free personal allowance starts to be withdrawn when your income exceeds £100,000
When your income tops £100,000 you might want to celebrate. But as soon as it does, you will be entering the 60% and over club. One of the highest income tax rate club’s in Europe that no dentist wants to be in.
The official rate of income tax for anyone with a taxable income between £50,000 and £150,000, is 40%. However, since 2010 there is a 60% rate anomaly for anyone earning over £100,000. This rate doesn’t officially exist but many thousands of dentists are affected by it.
As incomes rise and the £100,000 threshold remains the same, you are more likely to be affected.
How are dentist tax rates at 60%?
Everyone starts with a tax-free personal allowance, so you don’t pay any tax on the first £12,500 of your income. When your income goes over £100,000, the allowance starts to withdraw.
For every £2 you earn over £100,000, the personal allowance is reduced by £1. Once your income gets to £125,000, you have no personal allowance at all. The total cost of losing your personal allowance is an extra £5,000.
Example 1 – Darren is a self-employed dentist whose total income is £110,000.
- Darren is earning £10,000 over the £100k threshold
- On this £10,000, he pays 40% tax – this comes to £4,000
- His personal allowance has been reduced by £5,000.
- The £5,000 which had previously fallen within his tax-free personal allowance, is now being taxed at 40% – that’s an extra £2,000 of tax to pay.
- So if we add the £4,000 from point 2 and the £2,000 from point 4, this is £6,000 – which is 60%.
You can’t find this 60% rate advertised anywhere. It’s usually only when preparing your tax return that the full value of the loss of the allowance is first realised.
As soon as your tax rate exceeds 50%, psychologically, you begin to think who am I actually working for?
How are dentist tax rates at 62% for employed and self-employed dentists?
If under the state pension age, on top of your 60% income tax, you will be additionally paying 2% National Insurance on all your earnings above £50,000.
How are dentist tax rates at 75.95% for dentists with a limited company?
For a dentist with a company, the strategy is to extract funds as a directors salary below the personal allowance and dividend for the rest. 32.5% is the tax rate for dividends over £50,000. Before paying a dividend, corporation tax is paid on the company profits. With the interaction of the personal allowance withdrawal, the true tax rate is a staggering 75.95%
Example 2 – Divina is a dentist with her own limited company.
- Her total income as a director and shareholder is £110,000.
- On the last £10,000 of this, she pays 32.5% tax – which is £3,250
- Her personal allowance has been reduced by £5,000
- The £5,000 which had previously fallen within her tax-free personal allowance, is now taxed at 32.5% – that’s an extra £1,625 of tax to pay.
- So if we add the £3,250 from point 2 and the £1,625 from point 4, this is £4,875 – which is 48.75%.
- To pay a dividend of £10,000 to Divina the company must have made pre-tax profits of £12,345 (£10,000/81*100).
- The corporation tax paid by the company to pay a £10,000 dividend is £2,345
- Adding Divina’s personal tax liability of £4,875 to her company tax liability of £2,345 means, she is paying total taxes of £7,595 – 75.95%.
Many dentists form a company to save tax. This example highlights how you can end up paying tax at rates higher than if you were employed or self-employed.
What can I do about it?
There are seven possible ways to avoid the 60%+ dentist tax rate. When your taxable income is between £100,000 and £125,000 you can:-
- work less, and therefore earn less
- divert income away from you
- convert income from taxable to tax-free income
- plan for large purchases and claim tax-deductible expenses
- make tax-saving investments
- give it away
- defer the amount of income you pay tax on
It’s quite common for a dentist to work 4 or 4.5 days a week. If your earnings are at the 62% rate, reducing your annual income by £10,000 after income tax, National Insurance and NHS pension would only reduce your take home pay by £3,556. That’s just £68 a week.
What would you do with that extra time not working? More time with friends and family, develop a hobby or study?
As an employed or self-employed dentist, diverting your income to someone else to pay tax upon just isn’t possible.
However, if you operate your dental services through a partnership or a company, it is possible to have partners or shareholders to share profits with. Typically these partners and shareholders are family members who will be taxed on the profit shares and dividends they receive in their own names. Remember if you are running a partnership or a company under GDC rules all the partners and at least 50% of the company directors will need to be registered with the GDC.
You may well be making use of a tax-free personal savings and dividend allowances but these allowances form part of your total income and can push you above £100,000. It’s a well-established tax-saving principal if you have a spouse or civil partner paying taxes, at lower rates than you, consider transferring any savings or investments you are paying tax upon to them. This will save you tax on your income and increase the returns on your investments. Gifts between a husband and wife are free of any capital gains taxes.
Make taxable income non-taxable
Convert your taxable interest and dividends on cash and listed investments by transferring them to a tax-free ISA.
Plan for large equipment purchases and claim for all of your tax deductible expenses
Planning your business profits can be challenging and difficult to predict. It is possible to lower business profits, by having good knowledge, of what can be claimed as legitimate tax deductible expenses, by planning the timing and financing of any large capital purchases. For example, buying a digital scanner timed to fall in the right tax year.
Make tax-saving investments
You can make pension contributions and you’ll get tax relief at a fantastic 60%. You will need to check that you haven’t breached either the £40,000 annual or £1.25m lifetime contribution allowance. Remember, it is the total of both yours and the NHS contributions or any other employer that goes towards the allowances.
Investments into Seed Enterprise Investment Scheme (SEIS) have 50% tax relief. Investments into both Venture Capital Trusts (VCTs) and Enterprise Investment Scheme (EIS) are eligible for 30% income tax relief.
Give it away
Donations to registered charities work exactly the same for tax relief as pension contributions and can be backdated a year. By making a donation before you file your next tax return, you can claim a refund for the tax paid the previous year.
A full-time student is unlikely to be using all of their tax-free allowances. If you’re a parent with adult children who are studying give them your income-producing investments. This has the advantage of taxing income on your children and provides them with an income for their studies.
The gifting of assets such as shares and property may result in the payment of capital taxes and stamp duty. This can be difficult to justify when no cash has been received. Asset ownership ultimately tends to be more important than the tax.
You can give assets to trusts and pension funds. Once given away it may be possible to enjoy the use of an asset without having to pay tax on the income.
Defer the amount of income you pay tax on
By changing the year-end of your self-employed accounts it is possible to move accounting profits into a different tax year. Using the cash basis of accounting can also move profits into a different tax year.
If you run a company, rather than having a taxable salary or dividend you can take a tax-free loan instead. Taking a loan from the company will have tax consequences for the company that will need to be considered.
It may be possible to delay drawing your pension to a later date for an increased amount or/and a lump sum. Rather than working and receiving a pension on which you pay tax on both, wait until you stop working and replace your working income with income from your pension, often at a higher rate.