With regard to Income Tax calculations, the software always carries-out 2 sets of calculations, in any given year:
- Firstly, tax is applied to each individual, at source, making some assumptions about the individual’s tax status (regarding the relevant tax band).
The software makes an assumption regarding the appropriate 'standard rate cut-off point' for each individual. Where the individuals are married, the software starts by assuming that the relevant 'Standard Rate Cut-Off Point' is that for a 'Married/One' individual. Where the individual is single, the software starts by assuming the relevant 'Standard Rate Cut-Off Point' is that for a 'Single Person'.
Available 'Income Relief' (e.g. pension contributions) and 'Tax Deductible Expenses' are applied to the individual’s Gross Taxable Income to determine 'Total Taxable Income'. NB: For the purpose of calculating personal income tax at source, however, ‘Tax Deductible Expenses’ are not (yet) factored-in to the equation.
- Secondly - at the end of each year - the software calculates total (combined) taxable income, applies the appropriate tax band, and calculates whether - in fact - too much, or insufficient tax has been deducted during the year. It is at this point that ‘Tax Deductible Expenses’ are factored-in to the equation.
Any correction (either a credit or a further deduction) that is needed will be made in the following year.
Income from certain, specific, sources is always taxed in arrears:
- Other Income
- Windfalls
What follows below is a sample calculation for each of the following cases:
- Married/Two Incomes
- Married/One Income
- Single Person
Married – 2 incomes:
Example 1 – married individual (primary client), with ‘gross taxable income’ of 61,000 plus DC pension contributions of 8,500 and 2,500 tax deductible expenses:
PAYE calculations: -
- 61,000 less 8,500 = taxable income of 52,500
- Assumed 'standard rate cut-off' = 42,800
- 42,800 @ 20% = 8,560
- 9,700 @ 40% = 3,880
- Assumed personal liability = 12,440
Having estimated the personal liability of the primary client, the software now seeks to apply the relevant 'tax credits' – 'Married Personal Credit' and 'Spouse PAYE Credit':
- Assumed liability of 12,440 less total 'tax credits' of 4,950 = 7,490.
The primary client’s income tax, deducted, at source, therefore, will equate to 7,490.
Where the primary client’s spouse also has taxable income, the same logic will be applied, e.g. spouse has 62,500 of taxable income:
- Assumed 'standard rate cut-off’ = 42,800
- 42,800 @ 20% = 8,560
- 19,700 @ 40% = 7,880
- Assumed personal liability = 16,440
The PAYE income tax of the primary client’s spouse, therefore, will equate to 16,440.
End of tax-year calculation: -
- For the purpose of the ‘end-of-year’ tax calculation, the software aggregates the individuals’ gross incomes, to determine combined ‘Gross Taxable Income’. (123,500 in our example, above).
- Total ‘Income Relief’ and ‘Tax Deductible Expenses’ are applied, to determine ‘Total Taxable Income’. (112,500 in our example).
At the end of the tax-year, the software is able to determine what is, in fact, the appropriate ‘standard rate cut-off point’ for the individuals. Where the couple are both earners, the software will calculate the appropriate ‘cut-off point’. In our hypothetical example, the individuals are entitled to the maximum for a ‘married couple/two incomes’ of 67,600.
- 67,600 @ 20% = 13,520
- 44,900 @ 40% = 17,960
- Calculated total liability = 31,480
Having calculated the total, combined liability of the clients, the software now seeks to apply the relevant ‘tax credits’ – ‘Married Personal Credit’ and ‘Spouse PAYE Credit’:
- Total liability of 31,480 less total ‘tax credits’ of 4,950 = 26,530.
Because only 23,930 was deducted at source, via PAYE, the software recognizes that insufficient tax has been paid and calculates that a further payment of 2,600 (in this instance) is due. This payment will be levied in arrears.
Married – 1 income:
Example 1 – married individual (primary client), with ‘gross taxable income’ of 61,000 plus DC pension contributions of 8,500 and 2,500 tax deductible expenses:
PAYE calculations: -
- 61,000 less 8,500 = taxable income of 52,500
- Assumed ‘standard rate cut-off’ = 42,800
- 42,800 @ 20% = 8,560
- 9,700 @ 40% = 3,880
- Assumed personal liability = 12,440
Having estimated the primary client’s personal liability, the software now seeks to apply the relevant ‘tax credits’ – ‘Married Personal Credit’:
- Assumed liability of 12,440 less total ‘tax credits’ of 3,300 = 9,140.
End of tax-year calculation: -
- For the purpose of the ‘end-of-year’ tax calculation, the software now applies the ‘Tax Deductible Expenses’, to arrive at ‘Total Taxable Income’. (50,000 in the current example).
At the end of the tax-year, the software is able to determine what is, in fact, the appropriate ‘standard rate cut-off point’ for the individuals. In this instance, the software has correctly applied the ‘Standard Cut-Off Rate’ for a ‘Married/One’ individual.
- 42,800 @ 20% = 8,560
- 7,200 @ 40% = 2,880
- Calculated total liability = 11,440
Having completed the 'end-of-year' calculation for the primary client, the software now seeks to apply the relevant ‘tax credits’ – ‘Married Personal Credit’:
- Total liability of 11,440 less total ‘tax credits’ of 3,300 = 8,140.
Because 9,140 was deducted at source, via PAYE, the software recognizes that too much tax has been paid and calculates that a rebate of 1,000 (in this instance) is due. This receipt will arrive in the following year.
Single Person:
Example 1 – single individual (primary client), with ‘gross taxable income’ of 61,000 plus DC pension contributions of 8,500 and 2,500 tax deductible expenses:
PAYE calculations: -
- 61,000 less 8,500 = taxable income of 52,500
- Assumed ‘standard rate cut-off’ = 33,800
- 33,800 @ 20% = 6,760
- 18,700 @ 40% = 7,480
- Assumed personal liability = 14,240
It is assumed that the individual qualifies for the ‘Single Person Credit’ of 1,650.
- Assumed liability of 14,240 less total ‘tax credits’ of 1,650 = 12,590.
End of tax-year calculation: -
- For the purpose of the 'end-of-year' tax calculation, the software now applies the 'Tax Deductible Expenses', to arrive at 'Total Taxable Income'. (50,000 in the current example).
At the end of the tax-year, the software is able to determine what is, in fact, the appropriate ‘standard rate cut-off point’ for the individuals. In this instance, the software has correctly applied the ‘Standard Cut-Off Rate’ for a ‘Single Person’.
- 33,800 @ 20% = 6,760
- 16,200 @ 40% = 6,480
- Calculated total liability = 13,240
Having completed the 'end-of-year' calculation for the primary client, the software now seeks to apply the relevant 'tax credits' – 'Single Person Credit':
- Total liability of 13,240 less total ‘tax credits’ of 1,650 = 11,590.
Because 12,590 was deducted at source, via PAYE, the software recognizes that too much tax has been paid and calculates that a rebate of 1,000 (in this instance) is due. This receipt will arrive in the following year.