The true cost of the personal allowance stealth tax

When an individual’s adjusted net taxable income exceeds £100,000, their personal allowance for the tax year is gradually reduced. For every £2 of additional adjusted net income received over £100,000, the personal allowance is cut by £1. Once adjusted net income reaches £125,140, the full personal allowance is withdrawn.

This means that someone paying the main UK rates of income tax with adjusted net income between £100,000 and £125,140 faces an effective income tax rate of up to 60% on that portion of their income. Scottish resident taxpayers may presently incur an effective 63% income tax rate on this portion of income, which may increase to as much as 67.5% from April 2024 when the advanced rate of income tax is introduced. In addition to the income tax, taxpayers may also incur National Insurance contributions (NICs) on that portion of income, further increasing their tax burden. 

When the measure was first introduced only 588,000 taxpayers had total taxable income of £100,000 or more, but as the taper threshold has never been increased, thousands more taxpayers have been dragged into the 60% tax trap since 2010. One of the longest standing stealth taxes and this hidden tax band is still poorly understood by many.

Following a Freedom of Information request, RSM has received information from HMRC that the number of taxpayers now affected has more than doubled and currently stands at 1.35million. 

A breakdown of the number of taxpayers with total income over £100,000 by region for the 2021/22 tax year and 2022/23 tax year is as follows:

In the last five years alone, the amount of income tax generated as a result of the personal allowance taper amounted to £18.6 billion.

The estimated amount of income tax generated from the personal allowance taper over the five tax years to 5 April 2023 is as follows:

The personal allowance itself has also been frozen at £12,570 since 2021 and is due to remain frozen for six years until 2027/28. The Office for Budget Responsibility estimates that the six-year freeze of the personal allowance and higher rate threshold will raise £35.7 billion by 2028/29.

The freeze on allowances has significant implications for taxpayers. As wages increase over time, more people find themselves paying higher rates of tax or start paying tax for the first time, even if their incomes have not grown sufficiently to keep up with inflation. The recent Spring Budget did little to alleviate the impact of years of tax by stealth, with the announced reduction in NIC rates only beneficial to those with earned income, and many will feel the pain of these measures for years ahead.

Going beyond the eye-watering marginal tax rates caused by the taper of the personal allowance, the £100,000 adjusted net income threshold can also cost taxpayers their entitlement to valuable childcare subsidies, as explained in this previous article.

It is at least relatively easy to avoid the 60% tax trap if a taxpayer is close to the threshold provided they plan ahead. The £100,000 threshold is based on ‘adjusted net income’; total taxable income less certain tax reliefs, including trading losses, Gift Aid donations and pension contributions. As the tax year end approaches, individuals who are near the taper threshold may benefit from making a pension contribution or charitable gift to reduce their adjusted net income to below £100,000.