Tax credit system not as complex as it first seems

Old habits die hard, especially when it comes to paying tax. The introduction of the new tax credit system has lead to more than a few furrowed brows when calculating tax payable. A Family Money reader has asked us to clear up the confusion in as simple a way as possible.

The old system of tax allowances deducted amounts from a person's gross income. The new system of tax credits only begins to deduct tax payable after the income has been placed in the relevant tax bands. The new system is less complicated than it may first appear. To work out a tax bill, first add up all income from different sources and place it in the relevant tax bands to work out how much tax is owed.

If calculating tax for the 1999/ 2000 tax year the following Budget provisions from April 6th, 1999, apply. The first £14,000 (€17,776) of a single person's income and the first £28,000 of a married couple's income will be taxed at the standard rate of 24 per cent, with the balance subject to tax rate of 46 per cent.

Therefore, a single person on £20,000 will pay £6,120 in tax - £3,360 as a result of applying the 24 per cent rate to the first £14,000 of income while a further £2,760 results from taxing the balance of £6,000 at 46 per cent.

Next, the various allowances including the basic personal allowance, PAYE allowance and other allowances such as VHI and mortgage relief should be added up, allowed at the standard rate of 24 per cent and deducted from the tax due.

A single person with no mortgage, health insurance or pension would be entitled to the basic personal allowance of £4,200 and PAYE allowance of £1,000, a total of £5,200. If the standard rate is then applied, this gives a figure of £1,248 which is deducted from the original tax liability of £6,120 to produce a tax bill of £4,872.

Under the previous system such an earner would have paid £5,183, so they save £361 or 2.6 per cent of their net income under the new tax credit system.

Although the changes attempt to simplify the tax code, complications will continue to arise until the change is completed because certain allowances are still allowed at the marginal rate of tax. The tax credit system is being phased in over several years and most of the standard rating changes will take place by April of this year.