Good news everybody! Your net pay is likely to be £60 higher this month and £10 higher until next March as result of tax changes announced earlier this year.
This week's headlines were dominated by the government's £1bn plan to boost the housing market and the relaxation of stamp duty. But there is another boost to the economy due this month too. This is the reduction in income tax which arises from the compensation plan surrounding the removal of the 10% tax band. For most people, this will mean their pay packet is £60 greater in September and £10 greater from October through to next March.
A quick recap
This chain of events began back in 2007 when Gordon Brown decided to replace the two income tax bands of 10% and 22% with one band of 20%. Although some people gained, millions of low earners ended up paying more tax when the change came into effect in April 2008. After a period of protests and government navel-gazing, a plan to partially compensate those who lost out was announced, namely raising the tax-free personal allowance by £600.
With basic-rate tax of 20%, this higher tax-free allowance translates into a tax reduction of £120 for most people. Higher-rate taxpayers miss out, as they have to pay an additional £120 tax at 40% cancelling out the effect of the higher personal allowance.
Due to the way the Pay As You Earn system works, most people will get half of this tax reduction, i.e. £60, via an increase their pay packets at the end of September, followed by a smaller £10 increase for the remaining months of the tax year (October to March). So if you were paid £1,500 in August, you should get £1,560 in September and £1,510 from October.
You can find more details on exactly how the changes work on the HMRC website. As always with our lovely tax system, the situation is a lot more complicated than it needs to be.
What about next year?
While this is all good news, there is still a big question mark over what happens next tax year. It appears that this additional £600 of personal allowance was a one-off, so many people could see their net pay fall in April 2009, although the exact amount will depend on what other changes to rates and allowances the Chancellor makes in his next Pre-Budget Report. This will probably be delivered sometime in October, although no formal date has been made public yet, so we won't have to wait too long to find out.
The cost of this one-off increase in allowances was around £3bn so it's something the government would rather not have to continue.
Check that tax code
In the last month, you probably received a PAYE Coding Notice from HM Revenue & Customs which contained details of the increased personal allowance and the new tax code your employer uses to calculate how much tax to deduct each month. It may not be top of your list of priorities, but it's worth taking a few minutes to get a basic understanding of how these tax codes work and to make sure yours is correct.
In order to calculate your tax code, the government adjusts people's tax free allowance up or down for a number of factors such as pension payments and benefits like private health. However, these adjustments are often based on the information from the previous year. Our circumstances can change of course and our tax code can quickly become out of date as a result, meaning you pay too much or too little tax.
If you fill in a tax return, it's less of an issue, as any tax over or under paid as a result of an incorrect coding will be adjusted for when you pay your final tax bill.
If you don't fill in a tax return it's a different story. I recently came across someone who had a BR tax code, meaning she was paying tax at the basic rate on all her income and not getting any benefit from her tax-free personal allowance. We looked at her payslips and discovered this situation went back two jobs ago to 2003. We suspect her then employer never got her P45 from her previous job and she was put on the BR code as a temporary measure and has remained on it ever since.
A letter to the taxman followed, including all the documentation we could muster. Within a month and with hardly any fuss, it had been all agreed and she received tax repayments of around £6,000. So always check your tax code!