Are you subject to the Scottish 67.5% tax trap?

While Scottish income tax rates and bands mean lower earners pay less tax than those in other parts of the UK, high earners could now be paying up to 67.5% in income tax.

This isn’t an official rate of income tax and isn’t mentioned in any legislation, but comes from the tapering of the personal allowance when your income goes over £100,000.

The good news is there are ways to reduce your taxable income - one of which is to make pension contributions - to effectively sidestep this tax pitfall.

Impact of the new tax rate change

Following last year's Scottish Budget, a new Advances Rate of Income Tax was introduced from 6 April 2024 whereby Scottish taxpayers will pay 45% on earnings between £75,000 and £125,140 and 48% thereafter. However, the reality is those earning between £100,000 to £125,140 will be paying an effective rate of 67.5% which is a 4.5% increase from last year.

The reason for this effective rate of tax is due to the loss of your personal allowance. If you earn more than £100,000, your personal allowance of £12,570 is reduced by £1 for every £2 that your income exceeds £100,000 until it reduces to NIL at £125,140. Once it reaches NIL, not only have you lost your tax-free allowance, but you will have reached the Top Rate tax threshold and be straight into the realms of 48% income tax (up from 47%).

For anyone with earnings between £100,000 and £125,140, it is this reduction in personal allowance (which creates an additional tax rate of 22.5%), combined with the advanced rate of 45% tax, that results in the 67.5% tax rate.

For example, a higher-rate taxpayer earning £100,000 receives a bonus of £10,000. This £10,000 bonus is taxable at 45% resulting in a tax liability of £4,500. Then, as the income has breached £100,000, the personal allowance begins to reduce by £1 for every £2 over. The £10,000 bonus now reduces the tax-free personal allowance by £5,000 effectively subjecting previously untaxed income to the Advanced Rate of tax (45%) resulting in a further tax liability of £2,250.

That means that the original £4,500 tax paid, plus the additional £2,250 due because of the personal allowance reduction, gives a total of £6,750 of income tax paid on the £10,000 bonus; an effective rate of 67.5%.

Reducing your taxable income

There are ways you can look to reduce your taxable income, which can be particularly attractive if you are just over one of the thresholds, one of which is by increasing your pension contribution.

Depending on your earnings, this could mean you avoid the 67.5% pitfall, while also enhancing your retirement benefits.