Income Tax in 2023: How to make the most out of opportunities
James Kipping · January 12th 2023 · read
Rates and allowances
The tax-free personal allowance for the 2022/23 tax year is £12,570, the same as in 2021/22.
The next £37,700 is taxed at the basic rate of 20% (8.75% for dividend income).
Higher rate tax of 40% (33.75% for dividends) is charged on income above £50,270 and additional rate tax (ART) of 45% (39.35% for dividends) is charged on income above £150,000. The ART will be lowered to £125,140 from 6 April 2023.
Note that dividends are treated as the top slice of income, so the basic and higher rates are first allocated against other income.
Under current guidance, the allowances remain at the above levels until the 2027/28 tax year.
The personal allowance is reduced by £1 for every £2 of income above £100,000. There is therefore no personal allowance at all where income exceeds £125,140. Therefore, the effective rate of tax on income between £100,000 and £125,140 is 60%. This means that the effective rate of tax relief on pension contributions and gift aid donations is 60% within this income band.
Gift aid and pensions
Sufficient gift aid donations and/or personal pension contributions can be made, where possible, to mitigate the impact of the tapering of the personal allowance.
In order to maximise tax relief, sufficient income should be generated where possible to fully utilise the personal allowance and basic rate band. This may be done by careful planning of the timing of dividends from a private company or distributions from a family trust.
The personal savings allowance entitles basic rate taxpayers to £1,000 of tax-free savings income and higher rate taxpayers £500. However, additional rate taxpayers receive no allowance. The dividend tax allowance of £2,000 is available for all taxpayers. Amounts falling within the dividend allowance are taxed at 0%. The allowance will, however, use any part of the lower rate bands that they would otherwise have fallen into.
Please note the dividend allowance will fall to £1,000 from 6 April 2023 and then to £500 from 6 April 2024. Dividends in ISAs will continue to be entirely tax-free.
Dividends can be taken prior to 5 April 2023 to utilise the dividend allowance if not already done so.
Married couples can effectively transfer 10% of their personal allowance to their spouses or civil partners by making an election. Tax relief is given via a tax reduction of 20% of the transferred amount, £1,260 for 2022/23.
This transfer is only available if both parties are not higher rate or additional rate taxpayers. It should be remembered that children also have tax free allowances that may be utilised, subject to the settlements legislation.
There is potential to divert income from grandparents or other relations (not parents) in order to utilise a child’s personal allowance. This can be achieved by creating a family trust as part of an Inheritance Tax planning exercise. Professional advice should be sought before undertaking this.
If you or your partner receive child benefit, it is important to remember that taxpayers with adjusted net income in excess of £50,000 are liable to the high-income child benefit charge.
The charge will be levied on the higher earning partner. The charge is 1% of the full child benefit award for every £100 of income between £50,000 and £60,000. Where income is more than £60,000, effectively all child benefit is lost. You can elect not to receive child benefit if you or your partner prefer not to pay the charge.
Basis period reform
The Government announced a reform of the basis period rules for sole traders and partners in the Autumn Budget 2021.
From 2024/25 the profits of the tax year will be the profits arising in that tax year. The transitional year of 2023/24 will be the current year basis period profits plus the transitional period profits from the accounting year end to 5 April 2024.
Full relief will be given for any overlap relief and no further overlap can be created. Any additional profits arising for the business under the new rules will be spread over five tax years starting in 2023/24 with an option to elect to accelerate the tax charge.
This differs from the current year basis rules where a basis period for a tax year is the 12 months ending with the accounting date in that year, together with additional rules for the opening and closing years of a business or when there is a change in accounting period.
Review the impact of this change on your business and cash-flow projections, as in some cases it will bring forward tax payments significantly.