Exam Traps: Tax Stumbling Blocks – Income Tax

Taxation is one of the most complex and important topics that underpins much of financial planning – and it’s the topic that causes most consternation for students.

Tax is tested across multiple papers of the diploma and advanced diploma modules. It can seem complicated, but mostly it is about following a process or set of rules. Once you know the rules, you should be well on your way to exam success.

Here we examine Income tax an area that typically cause confusion or trip up students.

Income tax

Income tax also features in a number of exams. A common stumbling block is understanding how to calculate income tax.

First of all, make sure you read the question properly. If it states the person has taxable income, then this is income after considering the available allowances.

Income that falls within available allowances is not taxable. The first £12,500 of income falls within the current personal allowance (the allowance changes to £12,570 from April 2021).

Use the guide below for calculating income tax

1. Calculate gross income from all sources in this order:

  • earnings, including pensions and income from rental property;
  • savings income, but not chargeable gains from life assurance policies;
  • dividends;
  • chargeable gains.

2. Deduct any reliefs from income, such as business losses or interest on a loan to invest in a partnership.

3. Deduct the personal allowance. This is reduced for those earning more than £100,000 of adjusted net income, and lost completely at £125,000 or more. Extend the basic- and higher-rate tax bands if necessary, for example by the gross amount of pension contributions made via the relief-at-source method.

4. Work out the tax on the income, using the extended tax bands if applicable.

5. Finally, apply any tax reducers, such as a transferred personal allowance.

Tax is a subject tested across multiple papers of the diploma and advanced diploma modules and it’s a topic that causes most consternation for students. Need extra study support? Check out our range of CII courses: https://redmilladvance.com/courses/

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