Your tax-free personal allowance starts to be withdrawn when your income exceeds £100,000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 an anomaly for anyone earning over £100,000 at 60%. This rate doesn’t officially exist but many thousands of dentists are affected by it.
Every year more and more dentists will be effected as incomes rise and the £100,000 threshold remains the same.
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. However, when your income goes over £100,000, the allowance is gradually withdrawn.
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. His personal allowance has been reduced by £5,000 ((110,000-100,000=10,000)/2). 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. As Darren is already paying £4,000 tax at 40% on the £10,000 earnings between £100,000 and £110,000 the total tax due is £6,000, which is 60%.
This 60% rate isn’t advertised anywhere and is only really understood when the personal allowance is taken away. Usually, this isn’t realised until your tax return is prepared for filing.
As soon as your tax rate exceeds 50%, psychologically, you begin to think who am I am 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?
The tax strategy for any dentist with their own company is always to extract the funds as a low directors salary below the personal allowance and dividends for all the rest. Dividend income is taxed at a personal tax rate of 32.5%. Because dividends can not be deducted from the profits of a company, 19% corporation tax is paid on the profits before paying a dividend. With the interaction of the personal allowance withdrawal, the true rate is a staggering 75.95%
Example 2 – Diviana is a dentist with her own limited company. Her total income as a director and shareholder is £110,000. Her personal allowance has been reduced by £5,000 ((110,000-100,000=10,000)/2). The £5,000 which had previously fallen within her tax-free personal allowance, is now being taxed at 32.5% – that’s an extra £1,625 of tax to pay. As Divina is already paying tax of £3,250 at 32.5% on the £10,000 earnings between £100,000 and £110,000 the total personal tax due 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 be able to pay a £10,000 dividend is £2,345 (£12,345-£10,000).
Adding Divinas 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 from a company to save tax. As this example highlights the interaction of personal and corporate taxes, they can often end up paying tax on their earnings at rates higher than if they were employed or self-employed.
What can I do about it?
There are seven possible ways to avoid the 60%+ rate. When your taxable income is between £100,000 and £125,000 you can:-
- 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 £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 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 the 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. Gifs 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 and by planning the timing and financing of any large capital purchases, such as, a digital scanner to fall the right side of a 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 and 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 to your favourite charity before filing your next tax return, you can claim you a refund for the tax paid in an earlier year.
If you’re a parent with adult children who are studying give them your income-producing investments. This has the advantage of taxing the income on your children rather than on you and providing them with an income for their studies. A full-time student is unlikely to be using all of their tax-free allowances.
The gifting 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.
Certain types of assets can be given to trust and pension funds. Once given away it may be possible to enjoy the use of an asset without having to pay tax on any of the income.
Defer the amount of income you pay tax on
Self-employment profits are taxed on a 12 month accounting period independent to that of the tax year. By changing the year-end of your accounts it is possible to move accounting profits into a different tax year. The same can be done by using the cash basis of accounting.
If you are running a company, rather than receive a taxable salary or a 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 is often possible to delay drawing a pension to a later date for an increased future 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.