The 2018-19 personal allowance is £11,850. At its simplest, this is the amount of taxable income that an individual can receive without income tax becoming due.
Since April 2010 the personal allowance has been reduced by £1 for every £2 of adjusted net income over £100,000. As of the 2018-19 tax year, the personal allowance is completely lost when adjusted net income reaches £123,700.
Adjusted net income is total income less a number of reliefs, the major ones being pension contributions and gift aid donations. This has therefore resulted in a 60 per cent marginal tax rate if taxable income is between £100,000 and £123,700.
As a pension contribution reduces adjusted net income, this also means that up to 60 per cent tax relief is available on the contribution. See Box One.
Marriage allowance
This is generally understood to mean that an individual can transfer 10 per cent of their personal allowance to their spouse or civil partner, provided neither are higher or additional-rate taxpayers.
This is not strictly accurate for a number of reasons. The higher earner must receive income below the higher-rate threshold, and so not be a higher or additional-rate taxpayer.
The lower earner must receive income of less than the personal allowance.
The amount that can be transferred is based on 10 per cent of the standard personal allowance, but it is subject to rounding. This means the transferable amount for 2018-19 is £1,190, even though the personal allowance is £11,850.
It is not possible to partially transfer personal allowance. See Box Two.
On receipt, the transferable allowance is a tax reduction calculated by multiplying the transferable amount (£1,190) by the basic rate of tax (20 per cent), giving a tax reduction of £238. This means that in 2018-19, if the higher earner is a Scottish taxpayer they still receive a tax reduction of £238, even if they pay the Scottish starter rate (19 per cent) or Scottish intermediate rate (21 per cent).
Either the lower or higher earner can request at any time that the transfer of the personal allowance stops. If the lower earner makes the request then the personal allowance will stop being transferred from the end of the tax year in which they make the request.
If the higher earner makes the request it will be backdated to the start of the tax year.
Dividend allowance
The 2018-19 dividend allowance is £2,000. This is equivalent to a 4 per cent yield on a £50,000 equity portfolio held outside a tax wrapper such as a pension or Isa.
The simple part is that there is no tax to pay on the first £2,000 of dividends. The more complicated part is that as the dividend allowance uses up the tax bands, dividends within the allowance must be taken into account when calculating the tax on the excess dividends.
Dividends and personal allowance
Another common personal allowance misconception is that when calculating income tax, the personal allowance is deducted from income in the same order as income is taxed; that is, non-savings, then savings, and finally dividend income.
The Income Tax Act 2007 is clear that the personal allowance is deducted from components of total income, and that this should be done in the way which will result in the greatest reduction in the liability to income tax.
If the personal allowance has not been deducted in the most advantageous way, then not only has more tax been paid than is necessary, but also the calculation itself is incorrect. See Box Three.
Personal savings allowance
The personal savings allowance is £1,000 for Scottish starter-rate, basic-rate and Scottish intermediate-rate taxpayers, £500 for higher-rate taxpayers and not available for additional-rate taxpayers.
Savings income within the personal savings allowance is not taxable, but it does use up the tax bands in the same way as dividends within the dividend allowance.
As it is adjusted net income that is used to determine an individual’s entitlement to the personal savings allowance, a pension contribution can have a disproportionate impact. See Box Four.
It is clear that even things as outwardly straightforward as personal allowances have hidden complexities. Understanding these complexities could be essential in ensuring the correct (often lower) amount of tax is paid.
Unless stated otherwise, all figures quoted are for UK non-Scottish taxpayers in the 2018-19 tax year.
Phil Warner is head of technical at Hargreaves Lansdown
