Any Answers Answered: Use of personal allowance
In a special Any Answers Answered video this month Giles Mooney and Tim Good tackle an issue that is asked time and time again on AccountingWEB.
The TAXtv hosts explain the “minefield” that is the allocation of the personal allowance, the interaction of interest of dividends and of earnings.
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In the video below Tim Good explains that if an individual has multiple sources of income, the first thing to do is allocate them to the rate bands, ignoring any allowances or reliefs, to the basic rate, higher rate and additional rate.
Good said you allocate first non-savings income (first to basic rate, higher and then additional), followed by the savings income which can be broken into two (interest which is the first part of the savings and then finally dividends). Nothing has changed here, he said.
However, the issue then is the offset against the different types of income of the personal allowances and any other reliefs that go against general income.
Good said: “But of course many taxpayers will have qualifying interest if a director had borrowed money to invest in shares in the company, or a partner borrowing for the business, or there may be sideways loss relief, anything that is available against general income will be added together with the personal allowance.
“And the allowances and reliefs have for a very long time under section 25 of the Income Tax Act 2007 been able to be offset in the way most favourable to the taxpayer,” he added.
Good said it was easy to assume that the allowances and reliefs should be offset in the same hierarchy against non-savings income, savings and then dividends, but the complications introduced by George Osborne in the form of the personal savings allowance and the dividends tax allowance, mean that in a large number of cases it is not advantageous to offset the allowances and reliefs in that order.
Watch the video below to find out the various complications on this topic and whether it’s better to set them off against dividends in priority to non-savings income and interest.
Giles Mooney also recently gave AccountingWEB a couple of examples to illustrate the issue for 2016/17.
Salary £38,000, dividend £10,000
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The obvious way to do it is salary minus personal allowance leaves £27,000 taxable at 20%
£5,000 dividend at 0%
Final £5,000 dividend taxed at 32.5%. Total bill £7,025.
Personal allowance of £6,000 against salary and £5,000 against dividend leaves:
£32,000 of salary taxed at 20%
£5,000 dividend at 0%
Total = £6,400 saving £625
£11,000 savings, £11,000 dividend
Rather than using the personal allowance against the savings, leaving dividend to be taxed at 7.5% (after the first £5,000), the total bill is £450.
Use the personal allowance £6,000 dividend and £5,000 savings. Then you’re left with £5,000 dividend and £6,000 savings.
You must tax that savings then dividend (after the personal allowance) so the £6,000 interest is covered by the starting savings rate band and the personal savings allowance and then £5,000 dividend at 0% (first taxable £5,000 dividend)
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