How to Use the 6 Steps to Calculate Income Tax
Last updated on September 25th, 2019 at 4:33 am
Previously, we went through the six steps to working out someone’s income tax liability; this week we are putting these six steps into practice – of interest to those studying for any of the CII R06, AF1 or AF5 exams.
This article is relevant to examinable tax year 2016/17.
You can find our previous post (complete with useful infographic) here.
Example
Jackie is aged 45 and single. She is self-employed and has profits in this tax year of £95,000. She also receives dividends of £6,400, interest from her internet savings account of £800 and an interest payment of £2,000 from an OEIC. Finally, she makes a pension contribution of £8,000 to her SIPP and an investment of £10,000 to an Enterprise Investment Scheme.
Step 1
This is where we add up the person’s earned and unearned income. You’ll remember that although earned and savings income are taxed at the same rates, dividends aren’t, so getting into the habit of separating them out will help to ensure the correct rates are applied. The only payment we need to gross up by 20% is the income payment from the OEIC of £2,000 as this is still paid net.
Step 2
Deductions can be made eg for business expenses, contributions to DB schemes and interest on certain business loans. We can ignore step 2 in our example.
Step 3
Take off the personal allowance. Jackie has a total income of £104,700 so we need to adjust this as it is more than £100,000. £104,700 – £100,000 = £4,700. Divide this by 2 to give £2,350. £11,000 – £2,350 means Jackie has a reduced personal allowance of £8,650.
Here's a useful example for working out income tax (in the UK) Share on X
Step 4
Determine whether the client has made any gift aid donations or net pension contributions. Jackie has made a net pension contribution of £8,000 so we gross this up by 20% and increase the basic rate band by £10,000.
Step 5
Calculate the tax.
![[Row 1] [Col 1] 1. Earned Income [Col 2] 2. Savings Income [Col 3] 3. Dividend Income [Row 2] [Col 1] £95,000 [Col 2] £800; £2,500 [Col 3] £6,400 [Row 3] [Col 1] (£8,650); [Col 2] £500 x 0%; £2,800 x 40% = £1,120 [Col 3] £5000 x 0%; £1,400 x 32.5% = £455 [Row 4] [Col 1] £86,350 [Row 5] [Col 1] £32,000 + £10,000 = £42,000 x 20% = £8,400; £44,350 x 40% = £17,740 [Row 6] [Col 1] Total = £27,715; Minus tax deducted at source = £500 = £27,215](https://brandft.co.uk/brandcore/uploads/CalculatingIncomeTax.jpg)
Step 6
Deduct any tax reducers. Jackie has made an investment into an EIS of £10,000 on which she can claim tax relief of 30%; this is deducted at this stage.
£27,215 – £3,000 = £24,215.
We hope this has helped you to tackle any income tax calculation you may be faced with.
Grab the resources you need!
If you’re studying for your CII AF1 exam, and you want to be happy on results day, you’ll need to be prepared. Grab our free taster to try out one of Brand Financial Training’s resources for yourself. Click the link to download the AF1 calculation workbook taster now!
Alternatively, you can download taster resources for R06, or AF5 if you’re preparing for one of those exams.
Over to You…
Did this help to put into practice the steps required in determining income tax liability?
