What is the Personal Allowance?
Every tax year, each taxpayer is entitled to a personal allowance relating to their income. This amount is set each year by the Chancellor of the Exchequer. For the tax year 2020/21 the personal allowance is set at £12,500.
The Personal Allowance is deducted from a taxpayer’s NET INCOME (see Proforma Income Tax Computation) before the remaining TAXABLE INCOME is then subjected to taxation.
The Personal Allowance is therefore an amount of income that is received tax-free each year.
The Personal Allowance is deducted from the different sources of income in a way that is most beneficial for the taxpayer. This means that it is usually, but not always, deducted in the following order;
1) NON SAVINGS INCOME
2) SAVINGS INCOME
If a taxpayer does not have enough income to use up all of their Personal Allowance, then the balance cannot be carried forward to the next tax year and will be lost.
However, there are situations where a taxpayer, can transfer 10% (£1,250) of their personal allowance to a spouse or civil partner, thereby not wasting any unused allowance. This is known as Marriage Allowance.
How does Marriage Allowance apply?
As long as neither spouse or civil partner is a higher rate or additional rate tax payer – i.e. they’re both either basic rate or not payers at all – then a spouse / civil partner can elect to transfer 10% of their Personal Allowance, if unused, to their spouse / civil partner.
This transfer does not then increase the receiving spouses Personal Allowance but acts as a tax reducer which reduces the recipients income tax liability by a maximum £250 (£1250 * 20%).
Is the Personal Allowance available to all earners?
Every tax-payer is allocated a Personal Allowance, however, once a tax-payer’s ADJUSTED NET INCOME goes above £100,000, then the personal allowance starts to be RESTRICTED.
What is ADJUSTED NET INCOME?
ADJUSTED NET INCOME = NET INCOME – GROSS PERSONAL PENSION CONTRIBUTIONS – GROSS GIFT AID PAYMENTS.
The starting point for calculating ADJUSTED NET INCOME is NET INCOME (see Proforma Income Tax Computation). The GROSS amounts of both PERSONAL PENSION CONTRIBUTIONS and GIFT AID PAYMENTS are then deducted.
How does the PERSONAL ALLOWANCE RESTRICTION work?
The restriction is calculated as follows; (ADJUSTED NET INCOME – £100,000) * 50%.
Another way to think about it is that for every £2 that ADJUSTED NET INCOME exceeds £100,000 then £1 of restriction applies to the PERSONAL ALLOWANCE.
For example, if ADJUSTED NET INCOME = £120,000 in a tax year, then the restriction is calculated as;
(£120,000 – £100,000) * 50% = £10,000.
And the PERSONAL ALLOWANCE of £12,500 is reduced to £2,500. (£12,500 – £10,000).
Once an individual’s ADJUSTED NET INCOME goes above £125,000 then the PERSONAL ALLOWANCE is reduced to zero.