There has been a great deal of confusion about how the new tax will operate, writes CAROLINE MADDEN

SINCE THE new income levy was unveiled in Budget 2009, there has been considerable confusion among taxpayers and employers as to how exactly it will operate. The fact that the Government has tinkered with it in the meantime hasn’t helped to clarify the situation.

In its original incarnation, the levy was to apply to all earners – regardless of whether their income came from employment, from a pension or from other sources. Then the Government rowed back and made an exception for those on low incomes. To compensate for this exclusion, a higher levy rate of 3 per cent was announced for high earners.

Another source of confusion, and indeed concern, is the treatment of severance payments for income levy purposes (see panel).

So how exactly does the income levy work and what do taxpayers need to know about it?

Q Do I have to pay the income levy?

AAs of January 1st, 2009, anyone who earns more than €18,304 a year will have to pay the income levy. This exemption limit increases to €20,000 per year if you are 65 or over.

Once your income goes over the minimum threshold, the levy applies to the full amount of your income, not just the portion that exceeds the threshold.

So for example, if you’re aged 23 and your gross salary for 2009 is €25,000, the levy will apply to the full €25,000, and not just to €6,696 (€25,000 minus €18,304).

Social welfare benefits are exempt from the levy, as is interest to which Deposit Interest Retention Tax (DIRT) has been applied. In addition, the levy does not apply to people who have a full medical card.

Q How is the income levy calculated?

AThe income levy is based on your gross income before any deductions for pension contributions, losses, capital allowances or tax credits.

There are three different rates of levy, depending on your level of income. A 1 per cent levy is charged on income up to €100,100 per year, a 2 per cent levy is charged on income between €100,101 and €250,120 per year and a 3 per cent levy is charged on income in excess of €250,120.

Remember that the higher rates are only charged on the portion of your income that exceeds the relevant threshold, not on all income.

So if your salary is €120,000 a year, you will pay 1 per cent on €100,100, and 2 per cent on the balance (rather than 2 per cent on your entire salary).

Q I’m a PAYE employee. How do I pay the income levy?

AIf you are a PAYE taxpayer, your employer is responsible for deducting the levy from your salary. The levy is calculated per pay period, and the rate applied is determined by the weekly or monthly threshold (see panel) – depending on how frequently you get paid.

Q Does the income levy apply to benefits-in-kind?

AYes, unless the benefit-in-kind is not regarded as income, for example a tax-exempt travel pass.

“The majority of benefits-in-kind are classified as notional pay, so, in effect, what the employer does is calculate the taxable value of that on a monthly basis and adds it into the payroll. So anything that’s subject to PAYE will be subject to the income levy,” explains Frances Farrell, a director in PricewaterhouseCoopers’ employment tax group.

Q I’m getting a bonus in 2009 that relates to work done in 2008. Will the income levy apply to it?

AUnfortunately, yes. Any payment that you receive this year, regardless of what year it relates to, will be subject to the income levy.

Q Okay, so I have to pay the income levy on my bonus. What rate will apply and could I end up overpaying the levy?

AIf you receive a bonus (or indeed a commission or overtime payment) in a particular week or month, it could push you up into a higher rate bracket for that particular pay period. As a result, when you look back over the course of the year, it could turn out that that you have overpaid the levy.

For example, if your total income in 2009 is less than €100,100, the applicable levy rate for the year will be 1 per cent. But if you received a sizeable bonus in one month, you may have been charged 2 or 3 per cent on some of it.

If this happens, and you’ve been in continuous employment with an employer throughout the year, your employer can make an adjustment at the end of the year and refund any overpayment.

If, however, you have not been in continuous employment with an employer throughout the year, the Revenue will deal with any income levy refund due.

Q My spouse and I are jointly assessed. Are we entitled to double threshold limits?

ANo. The thresholds apply to you and your spouse individually and can't be combined.

So, for example, if you earn €80,000 and your spouse earns €120,000, you will pay the levy at 1 per cent, while your spouse will pay 1 per cent on income up to €100,100 and 2 per cent on the balance.

However, there is an exception to this rule – and it relates to people of pensionable age. If one or both of you are aged 65 or over, and it turns out at the end of the year that your combined income is less than €40,000 (twice the single threshold for over-65s), you will be entitled to a refund from the Revenue of any income levy paid.

Q I’m self-employed. How do I pay the income levy for 2009?

AYou must make an income levy payment with your preliminary tax payment for 2009, and, as long as the correct amount of preliminary tax has been paid, any balance should be paid when you file your 2009 return.

So if you’re calculating your 2009 preliminary tax based on 100 per cent of your 2008 income tax liability, you must remember to add on the income levy, even though it didn’t apply back in 2008.

According to Farrell, many self-employed people are not aware of this obligation.

“It’s buried in the back of the legislation, and it’s not being communicated, so you’ll have people who are used to making their preliminary tax payment based on their assessment for the previous year and will just make that payment and forget the fact that this needs to be factored in,” he says. “It’s not widely known yet.”