Income tax is collected on slices of an individual’s income. The first slice is tax free – that’s £8,105 (for 2012/13), more if you were born before 6 April 1948. The next slice of £34,370 is taxed at 20%, the next £115,670 at 40%, and anything extra at 50%. Dividends are taxed at slightly different rates.
The problem is that the slices of income are calculated per person, not per family, when in most families the income is shared, irrespective of who earns it.
Take two families with two young children, who claim child benefit of £1,752.40 per year.
In one, H and W each earn £45,000. They pay about £12,120 in tax and NIC each, leaving the family with £65,760 net income plus the child benefit of £1,752.
In the other couple; H earns £90,000, and W has no income. H pays about £31,020 in tax and NIC, leaving the family with net income of £58,980, and from 7 January 2013 onwards the family’s child benefit will be clawed back in full. That will be £438 in 2012/13 and £1,752 in 2013/14 – payable by H, unless W chooses not to receive the benefit.
The figures show that it makes sense to transfer some income from the high earner to the lower earner in order to take advantage of the tax free and lower taxed slices of income. This is not always easy to do, but the following methods are possible:
- an outright gift of savings and investments which produce taxable income;
- putting savings and investments into joint names and sharing the income;
- employing the spouse in a business;
- taking the spouse into partnership.
HMRC can challenge some of these if they think the transfer is not genuine – it’s important to take advice to be sure that the plan will work.
Capital gains are easier to pass on for tax. If you are likely to realise a gain above your annual exemption (£10,600), you could transfer the asset to your spouse first and save up to £1,908 (if you are a basic rate taxpayer) or £2,968 (if you pay income tax at 40% or 50%).