Every person in the United Kingdom is potentially liable for income tax (and yes, that does include children and babies), and everyone between the ages of 16 and their state pensionable age is liable for National Insurance Contributions (NICs).
Calculating the amounts due is not only necessary for the Personal Tax assessments, but it is also useful to be able to check your own tax and NICs due.
Note that at present the Scottish rates of income tax is not assessable.
The various rates and bands and thresholds will be given to you in the assessment and will not need to be memorised. However, it is up to the candidate to understand which rates, bands or thresholds to use, and how. It is that knowledge that will be the differences between success and failure in the upcoming assessments.
The rates, bands and thresholds
National insurance contributions (NICs) are collected to pay for state pensions, some state benefits and also contribute towards the National Health System. Both employers and employees make payments, and it is the accurate calculation of these amounts that is of importance in the Personal Tax assessments.
To calculate how much an individual must pay the following thresholds amounts need to be identified
- Primary threshold (PT) and (ST) Secondary threshold (these are usually for the same amount, but do check what is given in the assessment)
- Upper Earning Limit (UEL)
Below are the 2017-18 rates, however, use those given in the assessment.
Income tax is a tax that funds all other public services. It is paid by the individual on all personal income subject to the Personal Allowance.
Below is an example illustrating how these thresholds affect the calculation of NICs, both for employer and employee.
An employee earns £48,000 per annum and has a tax code of 1150L. Calculate the NICs for the month and income tax for the month.
- Identify the thresholds and perform the calculation
Identify the ST with the corresponding percentage, subtract the ST from the salary, and multiply the remainder by 13.8%.
(£48,000/12) – £680= £3,320 x 13.8%= £458.16. The amount below the ST (£680) is multiplied by 0%, so the amount due on that is zero. Below is a diagram that may prove helpful in showing how the numbers behave.
Now for the employee’s contribution. It is here that the UEL is used. As can be seen from the above table, if an employee earns more than £3,750 per month, then the percentage used reduces from 12% to 2% but only on the amount greater than £3,750. There is therefore an extra calculation to perform, so have a look at the diagram to make sure you understand how the numbers below were calculated, and how they relate to the NIC table given above (and in the assessment).
(£48,000/12) = £4,000 per month.
So the amount due for the employee is £373.40. Add this to the employer’s NICs of £458.16 to show that the total NICs due for this employee for the month is £831.56..
A method very similar to the above is used to work out the employee’s income tax liability.
- Identify the Personal Allowance. In the example above the code is 1150L (meaning that the Personal Allowance is £11,500).
- Subtract that from the total pay
- Then, using the bands in the table above, multiply by the correct percentage.
Note that because income tax is calculated cumulatively, that is, on the total pay to date, the annual amounts are used here, deducting the total tax paid in the previous months from the total tax due.
In this example the employee is paying a total income tax liability of 7,900, calculated as follows:
£33,500 x 20% = £6,700
£3,000 x 40% = £1,200
One little last thing
There is a little complication for those individuals who earn more than £100,000 per annum. For every £1 above that amount 50p of the Personal Allowance is lost, so by the time the individual earns £123,000 there is no PA left. For the amounts between £100,000 to the easiest way to calculate the reduction is PA is as follows:
Subtract the £100,000 from the total salary, divide the remainder by half. The result is the amount by which the PA is lost. And that’s it. As Alexander the Meerkat would say “Simples”
Use life examples
The best way to practice the techniques involved is to use your own salary. Once you have confirmed that your tax deductions and NICs are correct (or not, but that is another story), then give yourself a pay rise – something you will deserve if you successfully complete the final level of your qualification. And practise the calculations on any amounts that you can think of. Make a game of it with your study buddies. Practice makes perfect, and there is nothing as wonderful as passing all the AAT assessments.
Keep calm and good luck.
Julie Hodgskin is a fellow member of AAT, runs a licensed accounting practice and is a technical materials author for CIPP.