In November's Pre-Budget Report, Alistair Darling took a leaf out of his predecessor's book and announced a range of income tax and national insurance contribution (NIC) changes, staggered to take effect over the coming years:

•  2009/10

The Chancellor has given up on his May suggestion that the out-of-Budget increase in the personal allowance (and corresponding reduction in the higher rate threshold) were a temporary fix to the problems created by the 10% band changes. For next tax year the personal allowance rises by 7.3% - above the automatic statutory indexation – to £6,475. Curiously, the other main allowances were only increased by the required 5%.

The starting point for higher rate tax will rise by £800 more than statutorily required to £37,400 of taxable income. However, the principle – but not the final number – had already been announced by Gordon Brown in his (final) 2007 Budget.

The increase in the higher rate threshold was accompanied by implementation another 2007 Budget announcement. This sees the upper earnings limit for main rate NICs aligned with the level of income at which higher rate tax theoretically begins to be paid (£844 a week in 2009/10). Thus some of next tax year's higher rate tax savings will be clawed back through higher NICs.

The impact of the income tax and NIC revisions is shown in the table below. The biggest winners are those with earnings of at least £43,875.

* Based on an employee under age 65 with a single personal allowance who is contracted in to State Second Pension. Tax credits are ignored.

•  2010/11

Mr Darling expects the economy to be well into recovery mode by 2010/11, so this is when the first of the tax increases begin. The personal allowance will be reduced in two stages:

•  If you have gross income of over £100,000, but less then £140,000, your personal allowance will be reduced by £1 for each £2 of income over £100,000, subject to a maximum total reduction of half the personal allowance. This is likely to mean that your personal allowance will be halved (to about £3,300) if your income is between about £106,600 and £140,000.

•  If you have gross income of over £140,000, your personal allowance is further reduced by £1 for each £2 of income over £140,000. This is likely to mean that you will have no personal allowance if your income more than about £156,600. The net effect would be that you would pay approximately an extra £2,650 in tax.

Both phased reductions create a band of income about £6,600 wide where the effective marginal tax rate is 60%.

•  2011/12

This tax year sees Mr Darling plan a repeat of the trick used by his predecessor in 2003. Rather than explicitly increase all income tax rates, the Chancellor plans to raise all NIC rates for employees, employers and the self employed by 0.5%. For example, if you are an employee contracted in to the State Second Pension Scheme, your NIC rates will become 11.5% and 1.5% against 11% and 1% now. Once again high earners come off worst because they will have a large slice of income on which their NIC bill rises by a half (thanks to a rate increase from 1% to 1.5%).

Very high earners will also pay more income tax, as 2011/12 marks the introduction of a new 45% top tax rate for taxable income of over £150,000. The same rate will also apply to all trusts which accumulate income, regardless of their income level. For dividends, there will be a corresponding new top rate of 37.5%.

ACTION

The Chancellor's planned income and NICs reforms – which might not survive the next general election – potentially have important repercussions for tax planning. What looked a sensible idea before the Pre-Budget Report may now be the wrong approach.

Call us today to fix a date for a review your tax planning, to cover both the approaching tax year end and for Mr Darling's longer term ideas.

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