Questions And Answers

Tax Free AllowancesI have just received my new tax-free allowance form and do not understand it. There appear to be a confusion of figures as well as some mention of euros. Can you explain in simple terms what it means?

Mr D.N., Dublin

First the good news . . . if all your income is taxed at 24 per cent, then very little will change as far as you are concerned with the new forms. The colour will be different - a beige tint rather than the blue panels and red type of years gone by - and there will be a slightly different layout to allow the Revenue to tell you what your allowances come to in both pounds and in euros. That will not mean much for the moment but it is no harm to get used to the idea as the forms will be in euros only in three years time one assumes.

For the rest of us - those who pay tax on part of their income at the higher 46 per cent rate - the situation is a little bit more complicated. Most of the confusion will be to do with the fact that certain allowances will show two figures. For instance, in the case of the PAYE allowance, taxpayers will see the line "1000 standard rated = 522". We will go into a bit more detail, but this essentially means that under the new system of tax credits, your £1,000 PAYE allowance for a single person is worth £522 if you are a higher rate taxpayer because all allowances are allowed now at only the standard 24 per cent tax rate. On the higher, 46 per cent rate, the £522 translates into £240.12 relief or 24 per cent of the original £1,000 allowance 522x46/100 = 240.12.

The reason for this is fairness. It has been argued in the past that increases in allowances benefited higher rate taxpayers to a greater degree than those paying at the standard rate. This was because the allowances were deducted from income before any tax was levied; in effect, this meant that each increase in allowances helped higher earners disproportionally as less of their income remained to be taxed at the higher rate. At current rates, they were basically gaining 46p in every pound the allowances increased while less well off standard rate taxpayers benefited only to the tune of 24p.

While some of the formulae may seem complex under the new system of tax credits, essentially what is happening is that all a person's income is taxed first at whatever rates are applicable. When the tax liability has been determined, you then deduct the allowances at 24 per cent.

The idea is not that strange. Anyone with a mortgage or private health insurance will already be receiving mortgage interest relief and medical insurance relief at the 24 per cent rate. All the Government has done is to extend this system to most of the reliefs/allowances on offer.

The change should mean that higher rate taxpayers would pay more but, for the tax year 1999/2000, which begins on April 6th, the Government also increased the allowances generously and widened the tax bands to ensure that no one's take-home pay dropped. The single person's personal allowance rises from £3,150 to £4,200 - a jump of 33 per cent. Married couples personal allowances rise by a similar amount from £6,300 to £8,400. The PAYE allowance also rises considerably - from £800 to £1,000 - an increase of 20 per cent. The amount of income, which falls within the standard rate of tax, climbs from the first £10,000 of taxable income for a single person (£20,000 for a married couple) to the first £14,000 of all income (£28,000 for a couple). Of course, those paying tax only at the standard 24 per cent rate will gain and that is what the system is designed to do.

So how precisely does the Revenue arrive at the figures on your new-look allowances form. Let's assume we are talking about a married couple paying tax at the higher rate. First of all they will be eligible for a tax-table allowance of £13,392. This is to compensate for the fact that all their income is taxed at 46 per cent, rather than taxing the first £28,000 at 24 per cent and the balance at 46 per cent.

Next comes the personal allowance. As a married couple the headline figure for the allowance is £8,400 this is then standard rated to £4,384. The formula for this and indeed all the main allowances - personal, PAYE, mortgage and medical insurance - is (A x 24%) / 46% where A is the headline allowance. In this case, (8,400 x 24%) / 46% = £4,384. In fact, the figure only works out at £4,382 and some change, but the Revenue has rounded it up.

The formula is precisely the same for the PAYE allowance - (1,000 x 24%) / 46% = £522 - or mortgage and VHI or BUPA.

To show how this impacts on the actual tax bill, let's assume that our couple has an income of £50,000 and let's leave the mortgage and medical insurance elements to one side for the moment, as they have not changed this year. Assuming both are working, in 1998/99 they would have had allowances of £7,900 £6,300 of a personal allowance and two PAYE allowances of £800 each. In addition, they would have had a tax table allowance of £9,566, giving total allowances of £17,466. The balance of their income - £32,534 - would have been taxed at 46 per cent, giving a tax bill of £14,965.64, plus £2,565 PRSI, including levies. That would leave a net income of £32,469.36.

The same couple on the same earnings in 1999/2000 would be taxed initially on the whole sum, less the tax table allowance of £13,392. That gives a sum of £36,608 liable to tax at 46 per cent producing a tax bill of £16,839.68 plus PRSI of £2,574, a total of £19,413.68. From this bill are deducted the allowances at the 24 per cent rate - a total of £2,496 (24 per cent of the married personal allowance of £8,400 and of the PAYE allowances of £2,000) - leaving a tax bill of £16,917.68 and net income of £33,082.32. All other things being equal, the couple is better off to the tune of £612.96.

Now just wait till we start doing it all in euros. . .

Please send your queries to Dominic Coyle, Q&A, The Irish Times, Fleet Street, Dublin 2 or e-mail to dcoyle@irish-times.ie. This column is a reader service and is not intended to replace professional advice. Due to the volume of mail, there may be a delay in answering queries. All suitable queries will be answered through the columns of the newspaper. No personal correspondence will be entered into.