Contractor guide: What are marginal tax rates?

As limited company contractors have the corporation tax increase on the radar for April 2023, along with the Small Profits Rate unveiled at Budget 2021, their tax liabilities are likely to gradually fluctuate.

Stripping your company operation as a contractor back to basics and re-structuring the way you pay yourself can offer shelter from potential tax storms while helping retain your tax position.

Here, Keith Tully of Real Business Rescue provides a a Marginal Tax Rates refresher, including how you can resolve HMRC tax payment arrears.

What are Marginal Tax Rates?

To answer the question simply, marginal tax rates is the term given that refers to the rate of tax you will pay for the next pound that you earn.

The percentage of tax that you pay mirrors your income bracket, with the marginal tax rate increasing in tandem. This will also be influenced by your personal circumstances and how you pay yourself.

For example, if you earn £50,000, you will pay the higher rate of income tax at 40% for the pounds earned thereafter, and you will no longer be entitled to full Child Benefit, therefore increasing your marginal tax rate. If you earn below £50,000, you will pay a basic rate of 20% and no tax at the lower rate.

As marginal relief aims to bridge the gap between the lower and upper corporation tax limits, strategic tax planning is instrumental in stapling your position in the 19% tax band.

The incoming corporation tax increase (in 2023) aims to level the financial playing field as the economy matures beyond recovery mode. This step by the government against enterprise appears to be aimed at recovering funds paid out for furlough and other Covid-19 emergency measures, introduced ever since early 2020 to help businesses through torrential trading disruption during the coronavirus pandemic.

Small Profits Rate – Disincentive or required corp tax adjustment?

As part of the Finance Bill 2021, tax legislation introduced, known as the Small Profits Rate will apply to those generating a profit below the £50,000 lower limit or exceeding the £250,000 upper limit. The Small Profits Rate (or ‘SPR’) is applicable on taxable profits and not turnover for limited company contractors outside IR35 and the rate is set at 19%. But the SPR will not come into force until April 2023, hopefully giving contractors time to heal their Covid-19 battle scars and get a grip of their IR35 status under the new off-payroll working rules introduced on April 6th 2021.

By restructuring your income and taking note of where income originates from, such as shares and dividends, you can mitigate your tax threshold. Scaling it back to fundamental income planning, you should operate with the mindset of assessing what your future tax standing could potentially be.

Time to Pay Arrangement - help is at hand

An often-forgotten HMRC support tool if your marginal tax rate starts to bite, and you need a breather from corporation tax or VAT, is a Time to Pay arrangement. If you find yourself weighed down by an increased liability, a Time to Pay arrangement can provide a gateway to negotiating a formal payment plan with HMRC. It’s worth noting that access to a TTP was initially widened in light of the coronavirus pandemic.

A Time to Pay agreement should permit you to split your overdue tax payments into affordable monthly instalments, typically over the space of 12 months. For your request to be successful, you must submit a realistic repayment proposition, for which a licensed insolvency practitioner can assist.

As Budget 2021 consisted of quick-wins to recoup funds redirected to Covid-19 recovery, the full extent of a tax system overhaul will come into view, with potential implications for your marginal tax rate, so contractors will need to keep vigilant even if we are on the exit part of the roadmap out of lockdown.