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Tax question - Tax on back pay

17 posts & 15 voices | Started 1 year ago by dan1980 | Latest reply from breatheeasy

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dan1980 - Member

Are there any tax experts out there that could help me out with a little question (or two!) I have?

I've been employed by the same company since 2003 my first role requiring GCSE level education. I started my current role in 2006, when there has been an ongoing pay and grading analysis at my workplace. The new role was much more challenging (requiring degree level education - which I have). I was told I couldn't have an increase on the pay scale because of the pay and grading analysis. This analysis came to an end, and I was left on the same point on the pay scale as before I changed my role. The role I moved into should have been a few points higher up the pay scale, so I appealed and won. This involved a full role analysis, so I'm not conning anyone, I do actually work hard!

As my role changed in 2006, I believe that my increase on the pay scale should be valid from my change in role in 2006, I'm going to ask for the difference in pay I should have earned between then and now. The total back pay should be fairly substantial if my back of an envelope calculation is correct.

So my question is, if I get this back pay, will it be taxed as of this tax year (thus pushing me into the 40% tax bracket), or will it be taxed according to when it should have been earned (I wouldn't have gone into the 40% tax bracket if I'd earned my salary at the correct, increased grade for my role) I'm wondering if because I went through an appeals process, the salary difference could be considered a mistake by my employer, and therefore I won't be unfairly penalised tax wise because of their error?

Posted 1 year ago #
Dougal - Member

Tax is applied when you receive the cash. In this case, that means you will indeed go into the 40% bracket.

If it was applied as to when you should have received it, that would be a loophole to backdate earnings to years where you were below the larger bracket.

Posted 1 year ago #
allthepies - Member

Ask for a one-off additional amount to cover the increased tax hit.

Posted 1 year ago #
BigJohn - Member

If you get it, ask them to put it into pension contributions.

Posted 1 year ago #
sucklingmatt - Member

its a pretty rubbish system, but unfortunately you are in the 40% bracket, sorry.

however, i wonder if this theory would work, im not to sure, i'll need to ask a tax advisor friend so don't quote me but

[/i]If say the higher rate tax rate threshold was set at 35,000 (can't remember exact numbers off my head) and you were on 34,000, you would be paying 20% tax...then you get a payrise to 35,000 which makes you a higher rate tax payer 40%, which makes you substantially worse off....could you move the extra 1000 into a pension, because they are tax deductable and you could claim it back....

I don't know if that will then put you into the BRT bracket , but it is a thought at least
You have done pretty good for yourself to get to higher rate since 2003...

... if you don't mind me asking what do you do

Posted 1 year ago #
dan1980 - Member

Sorry, I wasn't very clear.

Say (arbitrary numbers):

I started my current role in 2006 on £20K
This role should have paid £30K I won my appeal 5 years later and was awarded a pay increase to £30K

If I get back pay its £30K - £20K = £10K difference over 5 years = £50K
My taxable income for this year is my salary £30K + back pay £50K = £80K

The 40% tax bracket is £35,001+ this year.

I'm a research technician so don't earn quite this much (sadly) but the numbers give a good idea of the problem.

Posted 1 year ago #
fatboyslo - Member

sucklingmatt - Member
its a pretty rubbish system, but unfortunately you are in the 40% bracket, sorry.

[/i]If say the higher rate tax rate threshold was set at 35,000 (can't remember exact numbers off my head) and you were on 34,000, you would be paying 20% tax...then you get a payrise to 35,000 which makes you a higher rate tax payer 40%, which makes you substantially worse off....could you move the extra 1000 into a pension, because they are tax deductable and you could claim it back....

You forget that it is only the earnings OVER the higher threshold that are taxed at the higher rate, not the whole of your salary ... so you are not "worse off " you still get more in your pocket , just not such a high percentage of the extra.....

Posted 1 year ago #
dan1980 - Member

Although I'd be better off in getting the back pay, if I'd been paid the correct grade from the start I would never have gone over the 40% threshold over the 5 year period, so, in my example above, I'm going to get taxed at the 40% rate on £45K worth of the £50K back pay.

It just seems a tad unfair that I've done the job for the past 5 years, not been paid the right amount, my employer corrects their mistake, and Mr Tax man takes a chunk he shouldn't have had.

Posted 1 year ago #
toby1 - Member

Mr Tax man is not a fair man - just look at my last payslip and you'll agree! I get a bonus, he takes most of that bonus, the student loans company also take a %age based chunk and I'm left with the scrappings.

Posted 1 year ago #
poly - Member

Say (arbitrary numbers):

I started my current role in 2006 on £20K
This role should have paid £30K I won my appeal 5 years later and was awarded a pay increase to £30K

If I get back pay its £30K - £20K = £10K difference over 5 years = £50K
My taxable income for this year is my salary £30K + back pay £50K = £80K
good luck getting that! Even assuming the numbers were right, and the employer thinks you are invaluable and worth throwing away money to keep then they should probably be arguing 30k is the value you have today with 5yrs experience and so its a sliding scale over the last 5 years. Perhaps, if you are very lucky (i.e. important to them) getting you 1/2 the amount you hope for!

The 40% tax bracket is £35,001+ this year.

This is only on earnings above the personal allowance.

Personal allowance has just gone up to £7,475; you then pay tax at 20% on the next £35,000, ie up to £42,475. Earnings above that are then taxed at 40%.

If your figures were right then if you got all the backpay YOU THINK you are owed you would pay 20% tax on the bit between what you'd earn in 2011/12 anyway (30000) and 42475, and 40% on the bit between 42475 and 80k. My figures suggest you would pay something like £17,505 in additional tax (on 50k of extra income). As others have suggested ploughing some or all of this into pension would be an efficient way to reduce the tax burden (but of course you won't see it for another 30 odd years!).

Its worth bearing in mind that you have also "avoided" National Insurance on this extra earnings for 5 years. If you had been earning 30k rather than 20k for the last 5 years you would have paid an additional £6,000 in NI contributions (roughly - based on various assumptions and using the current NI rates because I am too lazy to look them up). If your employer gives you this extra £50k as one big lump sum you would pay only £1,104 extra NI.

So, 50k spread over 5 yrs at 20% = £16000 Tax and NI contributions
OR, 50k in one lump sum (on top of 30k salary) = £18609 (TAX & NI)

Not such a big discrepancy; especially since the figures will be lower for your actual salary.

If you get it I certainly wouldn't make a fuss about the tax! I suspect you've got minimal risk of getting enough backpay to put you in the 40% bracket anyway!

Posted 1 year ago #
FG - Member

The 40% tax bracket is £35,001+ of your taxable income, which pushes it over £42k.

As allthepies says though - ask your employer to pay a sum to cover the extra tax (plus cover on the extra sum).

Posted 1 year ago #
richcc - Member

You'll also have NI and may have employees pension contributions to pay on any back pay you may get

Posted 1 year ago #
aaron-bangor - Member

if you go into the 40% bracket be sure to claim 20% relif on any pension contributions you have made and charitable donations made (you get 20% back). Not widely known but you have to ask for it if a 40% payer.

Posted 1 year ago #
Esme - Member

Congratulations on your pay rise! If they agree to the arrears, it's important for it to be paid separately, and NOT through the normal PAYE system

There are mechanisms for paying the "correct" amount of tax and NI, such as through a PAYE Settlement Agreement

Your firm's payroll department should be able to deal with this. Otherwise I know a very good payroll bureau who can help . . .

Esme (former HM Inspector of Taxes)

Posted 1 year ago #
taxedone - Member

Reference:- http://www.hmrc.gov.uk/manuals/eimanual/EIM02530.htm

you can pay tax on back pay as though earned in the year to which the back pay relates, rather than the year in which you received it.

I have had this problem and phoned hmrc and the tax specialist at hmrc will argue that the tax is due in the year received, not the year earned. depends who you get on the phone.

Posted 3 months ago #
jambalaya - Member

Interesting theoretical question I'd say, there is little chance your employer will backdate your pay.

Posted 3 months ago #
breatheeasy - Member

^^^

what jambalaya says, unfortunately.

Posted 3 months ago #

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