There are times when all seems right in the world. Calm. Serene. Blissfully idyllic.
This was not one of those times.
It was the filing deadline for self-assessment tax returns. An event as predictable as daylight savings. Yet, like daylight savings, an event that somehow manages to catch out hordes of otherwise seemingly intelligent individuals year after year.
A person’s attitude towards tax is an interesting barometer of their character.
Intellectually, most of us recognise taxation as a core part of the societal contract.
Built upon the understanding that if we each contribute when we can, then society will step in to help us out when we are unable to help ourselves.
Taxation provides the funding for the public services that we all rely upon in our everyday lives. Schools. Hospitals. Public transport. Roads. Police. Firefighters. Garbage collectors.
Yet many of us don’t much like the idea of actually paying tax.
Concurrently believing tax is a burden that should be borne by everyone, while also believing that our own personal burden should be actively minimised up to the put where avoidance becomes evasion.
My father used to resent every dollar he paid in tax.
Viewing each one as a personal failing, for not conducting his affairs in a more tax-efficient manner.
He would salary sacrifice into his pension to avoid paying income tax. Operate rental properties at a paper loss rather than pay tax on rental income. Use leverage to ensure dividend income was offset by tax credits and financing costs. Avoid selling profitable investments, as the mere thought of paying tax on a realised capital gain cancelled out any joy at having made a successful investment.
An objective observer might have questioned whether these behaviours made financial sense?
Arranging his affairs with the primary goal of minimising taxable cash flows. As a consequence, his portfolio was entirely tilted towards future capital growth, while ensuring the holding costs were self-funding.
Yet in the game my father was playing, any time the taxman was denied the opportunity to pick his pocket, represented a clear win worthy of celebration.
Despite all that, when the time came he was more than happy to accept a pensioner’s concession card, and vast public healthcare subsidies on the eye-wateringly expensive life-extending chemotherapy drugs that would have otherwise bankrupted him had he been required to pay list price.
Today, that burden of taxation appeared to fall on one particular unsuspecting victim.
One who baited the panic monster by leaving the preparation of their tax return until the very last day.
Hours of frantic activity were spent attempting to document a whole year’s worth of financial activities.
Scrounging up unfiled notices and statements. Receipts. Records of charitable donations.
Resetting long-forgotten passwords to fintech apps and seldom visited brokerage websites.
Compensating for a year’s worth of apathy and neglect with a flurry of expletive-laden activity.
Numbers painstakingly gathered. Aggregated. Curated. Massaged. Spun. Teased. Tortured.
Carefully keyed into the tax authority website, via a truly awful user interface. One that could only have been “designed” by some combination of an evil cartoon bad guy, a committee of indecisive egotistical senior executives, or a consultancy administered series of iterative A/B tests.
Finally, it was done.
With trembling fingers, sweaty palms, closed eyes, clenched buttocks, churning stomach, and no small amount of trepidation they hit submit.
Progress indicators span. And span. And span. A cheap programming trick designed to distract the punters, as behind the scenes undercooked IT infrastructure creaked and groaned under the load it was being subjected to.
Aeons passed. Moments before the user lost the faith and hit refresh, the website returned a result.
The calculated amount of tax owed.
A big number.
A number greater than that received per year by old aged pensioners and universal credit recipients.
A number only slightly less than the annual median household disposable income.
An involuntary howl of anguish erupted from the throat of the taxpayer. Tears sprang from their eyes. Bowels turned to water. Stomach acid churned. A little bit of vomit crept into the back of their mouth.
The dawning realisation that things were far worse than they had initially appeared to be.
Not only had the tax authorities already laid claim to a vast portion of the taxpayer’s hard-earned income from throughout the year, but the tax owed calculation significantly exceeded what their employer had diligently been deducting from each pay packet.
For once, the employer was not at fault.
How could they know about any dividend, interest, rent, or royalty income that their employees might happen to have earned? Nor were they aware of any entrepreneurial earnings, ranging from genuine business ownership through to the scammiest of side hustles.
As the taxpayer carefully reread their tax assessment notice on the screen, things only got worse.
They desperately sought to find a mistake. A waiver. A miracle!
Instead, they discovered that not only did they owe a five-figure sum on their extracurricular earnings, they had also been charged interest for failing to have already provisionally paid a material portion of that amount.
The tax authorities demanded immediate payment of half the outstanding amount.
The second half was due by the end of January, just 13 short weeks away.
To the taxpayer’s increasing horror, a third half was demanded by the following July, in anticipation of next year’s similarly sized tax bill.
There was just one problem. The taxpayer didn’t happen to have a spare £10,000 stashed in a winter coat pocket or stuffed down the back of the couch cushions.
In fact, they didn’t have a spare £10,000 at all. Not to mention the multiple instances of such a figure, which the tax authorities had decided they were entitled to.
Instead, those amounts would need to be saved out of future after-tax employment earnings.
Alternatively, the taxes could be met via the sale of those same hard-won income-producing assets. Assets purchased from after-tax income. Sacrificing the goose that lays a recurring stream of golden eggs to meet a one-off outgoing.
An act that would incur even more taxation, on the resulting capital gains.
At this point, readers may be tempted to cue the tiny violins. Feeling little sympathy for someone with sufficient means to generate investment income in the thousands. Particularly one who lacked the foresight and common sense to have budgeted for the inevitable tax bill that must surely follow.
A valid criticism. However, before you pass judgement and the social justice warriors amongst you start frothing at the mouth and screaming accusations of “privilege” at your screens, spare a thought for the plight of the disorganised taxpayer.
In the United Kingdom, there exists an archaic and often bizarre tax system that is littered with traps, pitfalls, and inequity for the unwary. One such trap is what happens when a taxpayer’s pre-tax income creeps above £100,000 per year.
At that point, every additional £1 earned is subject to 40% income tax. No surprises there.
However, at that point every additional £2 earned also causes the taxpayer’s tax-free threshold to be clawed back by £1. What does that mean in practice? Each additional £1 earned over £100,000 is effectively being taxed at a rate of 60%.
While the taxpayer’s salary remained below that magic £100,000 threshold, their taxable passive income streams pushed them above it. Not only was the taxpayer liable for the income tax due on their investment earnings, but they were also on the hook for the additional tax due on their salary as a result of that reduction in tax-free threshold.
The result was the eye-watering sum that was now due.
An objective observer might remark that (generally) people only pay tax when they’ve made money.
That even after the tax has been paid, they are still financially ahead of where they would otherwise have been, had they not made the investment.
For the most part, that is true, though your mileage may vary if you are one of the endangered species of lesser spotted English private buy-to-let investors.
The taxpayer hulked. Swore. Cursed the gods. Stubbed their toe, after lashing out at a nearby piece of furniture.
Their instinctive reaction was to wonder why they worked so hard, when the tax authorities claimed so much of the rewards?
A day’s wages taxed at 40%. Then taxed another 11% via National Insurance for good measure.
If they saved and invested, rather than squandered, their after-tax wages they face even more taxes.
Investment income generated outside of tax-advantaged accounts were taxed.
Capital gains realised outside those same tax-advantaged accounts were taxed some more.
Yet somebody following the default life script experienced nothing like those vampiric attentions of the tax authorities. Work a permanent job. Contribute to the workplace pension. After-tax savings first serving as a house deposit, combined with as much mortgage as a lender will lend them, to purchase as much owner-occupied property as they could possibly afford.
Any future savings thrown into overpaying the mortgage. “Earning” a tax-free return in terms of reduced interest payments. That return a couple of percentage points greater than parking the same funds in a savings account.
Climb the property ladder. More house. Better location. All free from capital gains tax.
Once the mortgage is paid off, or at least under control, diverting those savings into a private pension. Tax-free on the way in. 25% tax-free lump sum on the way out. The rest taxed at whatever post-retirement marginal tax rate happens to apply.
An objective observer may be forgiven for wondering why the taxpayer wouldn’t cash in their investments and pour the after-tax proceeds into a house? The same question had occurred more than once to the disorganised taxpayer.
Tax can be an emotive topic just as much as a financial one. Pay it? Evade it? Avoid it?
Making a contribution to society, or having our pockets picked by an unscrupulous government?
Sometimes circumstance, lack of education, poor planning, or just “life happens” events result in unsheltered assets being held in taxable accounts.
Not all asset classes can be safely housed within tax-advantaged wrappers.
Art. Antiques. Collectables.
The taxpayer in our story scored some own goals, by failing to plan ahead to ensure they could meet the taxation obligations incurred as a result of their financial activities. A trap more than a few starry-eyed crypto investors potentially now find themselves facing when filing their self-assessment tax returns.
Particularly anyone foolish enough to use Bitcoin for its intended purpose, a form of currency, to actually pay for things! Where every single purchase potentially receives a complimentary capital gains tax bill.