Order of Taxation
Learn how different types of income are taxed and how they fit into a client’s income tax calculation.
In terms of income there are four main categories: non-savings non-dividend income, savings income (including offshore bond gains), dividend income and onshore bond gains. Onshore bond gains are classed as savings income but, due to the tax credit attached to them, they are taxed as the highest part of an individual’s income.
When dealing with clients with more than one source of income, it is important to understand the order in which each source is taxed.
Firstly, you need to consider non-savings non-dividend income. This includes employment income, self-employment income, pension income, rental income and some taxable state benefits for example state pension, jobseeker’s allowance, bereavement allowance.
Each tax year, almost every individual is entitled to a personal allowance and an individual’s personal allowance is always set against non-savings non-dividend income first.
Secondly, you need to consider savings income and dividend income. Savings income can consist of interest payments from banks and building societies, corporate bonds, interest from a fixed interest fund (OEICs/ GIAs) and offshore bond gains. Dividend income is payments such as dividend payments from shareholdings or dividend distributions from OEICs and unit trusts. Where an individual has both savings and dividend income, the amounts taken together are treated as the next part of their income, and the dividend income is taken as the highest part of the combined amount.
Finally, the highest part of an individual’s income is onshore bond gains and termination payments from employment.