Advanced Taxation (UK) · Income tax: the use of exemptions and reliefs in deferring and minimising income tax liabilities

Income Tax Planning for Individuals and Employment Income

Updated 11 October 2026 · Fact-checked

Income tax planning means legally reducing or delaying tax by using rates, bands, exemptions and reliefs. In ATX you identify the client's position, compare options such as shifting income to a spouse, timing receipts or changing the pay mix, calculate the tax saved for each, then recommend one and state the risks.

Understand Income Tax Planning for Individuals and Employment Income

Tax planning is not evasion. You use the rules as Parliament wrote them to cut the tax bill or push it into a later year. ATX tests this with a client scenario and an objective, such as 'reduce the family tax bill' or 'improve cash flow'.

The UK income tax system gives each person their own allowances and bands. Spouses and civil partners are taxed separately. So if one spouse pays 40% or 45% and the other pays little or nothing, moving income to the lower-taxed spouse saves tax. For an outright gift of income-producing assets, such as shares, the income then belongs to the new owner. Be careful if the gift is of the right to income only, or if the donor keeps control or a benefit. The settlements rules can then tax the income back on the donor.

Timing matters too. Tax is charged by tax year. You can sometimes bring income into a year with unused bands, or push it into a year when the rate will be lower. Reliefs such as pension contributions also reduce the tax rate paid on your top slice of income. Most income tax reliefs are capped at the higher of £50,000 or 25% of income, unless the relief is otherwise restricted.

For remuneration, compare the total cost to the employer and the net cash to the individual. Salary bears income tax and NIC (employee and employer). Dividends bear no NIC but are not deductible for the company. Employer pension contributions are generally deductible and carry no NIC, but they are limited by the annual allowance. Benefits in kind give a taxable benefit and employer Class 1A NIC, so they are often worse than cash unless the benefit is exempt.

Finally, deferral has a cost or a gain. If you underpay tax, interest runs at the rate on underpaid tax. If you overpay, you earn the lower overpaid rate. Interest is a number you can calculate, so use it to quantify the cash-flow effect of your advice.

Key rules to remember

Income tax bands (normal rates): Basic £1 − £37,700 at 20%; higher £37,701 − £125,140 at 40%; additional over £125,140 at 45%; The bands apply to taxable income after the personal allowance. Use the tax tables given in the exam.
Dividend rates: 8.75% basic; 33.75% higher; 39.35% additional; dividend nil rate band £500; The £500 nil rate band uses up part of a band. It does not extend the band. Dividends are taxed as the top slice.
Savings nil rates: Starting rate 0% on savings within the first £5,000 of taxable income; savings nil rate band £1,000 (basic rate taxpayer), £500 (higher rate taxpayer); The starting rate is lost where other income already fills the first £5,000.
Cap on income tax reliefs: Cap = higher of £50,000 or 25% of income; Applies unless the relief is otherwise restricted.
Beneficial loan benefit (average method): Benefit = official rate × average loan balance × months ÷ 12, less interest paid by the employee; Official rate is 3.75%. Loans of £10,000 or less in total are exempt. Employer also pays Class 1A NIC at 15%.
Interest on underpaid tax: Tax underpaid × 8.50% × months late ÷ 12; Use the rate given in the tax tables. Apportion to the nearest month per the supplementary instructions.
Interest on overpaid tax: Tax overpaid × 3.50% × months ÷ 12; Lower than the underpaid rate. Late payment is always costly relative to early payment.
NIC rates for remuneration choices: Employee Class 1: 8% on £12,571 − £50,270, 2% above. Employer Class 1: 15% above £5,000. Class 1A: 15%; Dividends have no NIC. Employment allowance is £10,500.
Annual allowance (pensions): £60,000 for 2023/24 to 2025/26; Tapering applies at high income (threshold income £200,000, income limit £260,000, minimum allowance £10,000). Without earnings, relievable contribution is limited to £3,600.

How to solve Income Tax Planning for Individuals and Employment Income questions

Use the same sequence for any planning requirement. It keeps your answer structured and earns both technical and professional skills marks.

1Read the requirement and the client's objective. Is it to minimise tax, defer tax or improve cash flow? Note any constraints such as 'wants to keep control' or 'needs cash now'.
2List each person's income by type, their tax year and their band position. Note who has unused personal allowance, basic rate band or nil rate bands.
3Identify the options the scenario hints at: transfer income or assets to a spouse, change the timing, change the pay mix, make pension contributions or use an exempt benefit.
4Compute the tax for the current position and for each option. Show workings. Compare the total tax, including NIC where relevant, and not just income tax.
5Check the conditions and anti-avoidance. For example, is the gift outright? Does the donor keep a benefit? Is the relief capped or restricted by the annual allowance?
6Add interest or cash-flow effects where payment dates change. Use the underpaid and overpaid rates from the tax tables.
7Recommend the best option in a clear sentence. State the tax saved, the risks and any assumptions. Keep the tone suitable for the client.

Quickest way: Marginal rate comparison

When to use it: When the question asks how much tax a move saves and you are short of time. It works for income shifting, dividends versus salary and pension contributions.

Find the marginal rate on the income for each person: 20%, 40%, 45%, or the dividend equivalents 8.75%, 33.75%, 39.35%. Watch for the 60% effective rate in the £100,000 to £125,140 band if the personal allowance is being withdrawn.
Subtract the rates to get the saving per £1 moved. Multiply by the amount moved.
Adjust for any nil rate band or allowance the recipient has unused, and for NIC if the pay type changes.
Check one condition: is the gift outright, and is the cap on reliefs or the annual allowance an issue?
Write the saving as one clear line, then add the risk.

Common mistakes in Income Tax Planning for Individuals and Employment Income

Ignoring NIC when comparing salary with dividends or benefits
The question seems to be about income tax, so students stop at income tax.
Fix: Include employee and employer NIC and Class 1A NIC in every remuneration comparison. Dividends carry no NIC but are not deductible for the company.
Treating the dividend nil rate band as an extra slice of the basic rate band
Students think a nil rate means the dividends are outside the bands.
Fix: The £500 nil rate dividends still use up part of the band. They are taxed at 0% but can push other income into a higher band.
Recommending income shifting without checking it is an outright gift
Students focus on the tax saving and forget the settlements rules.
Fix: State that the transfer must be outright and not wholly or mainly a right to income, and that the donor must not keep a benefit. Otherwise the income can still be taxed on the donor.
Using the wrong interest rate or the wrong direction
The three rates in the tax tables look similar: 3.75%, 8.50% and 3.50%.
Fix: Official rate (3.75%) is for beneficial loans. 8.50% is for underpaid tax. 3.50% is for overpaid tax. Write the name of the rate next to each use.
Forgetting that the relief cap and annual allowance limit pension planning
Pension relief seems unlimited when it is described as 'contributions reduce tax'.
Fix: Check the annual allowance (£60,000), tapering, carry forward and the cap on income tax reliefs. A relievable personal contribution is limited by relevant earnings, or £3,600 with none.
Giving a calculation with no recommendation or risk
Students run out of time after the numbers.
Fix: Always end with a clear recommendation, the saving and one or two risks. Professional skills marks reward this.

Worked examples

Example 1

Alan is a higher rate taxpayer. He has other income of £60,000 a year and owns shares in a private company that pays him dividends of £30,000 a year, so his total income is below £100,000 and his income is well below £125,140. His wife Beth has no other income. Alan is considering gifting half of his shares to Beth outright. Calculate the annual income tax saving. Assume Beth's personal allowance is £12,570 and the tax rates for 2025/26 apply.

Show the solution

Alan's other income of £60,000 less his personal allowance of £12,570 is £47,430. This already exceeds the £37,700 basic rate band, so all of his dividends fall in the higher rate band. His marginal dividend rate is 33.75%. His income is below £125,140, so the 39.35% rate does not apply.
Dividends moved to Beth: £30,000 × 50% = £15,000.
Alan's saving on the £15,000 moved: £15,000 × 33.75% = £5,062.50. His £500 dividend nil rate band is unchanged by the gift. He still has £15,000 of dividends, so he uses the full £500 before and after, and the saving is the full £15,000 at 33.75%.
Beth's tax: dividends £15,000 less personal allowance £12,570 = £2,430 taxable.
Beth's £500 nil rate band: £2,430 − £500 = £1,930 taxed at 8.75% = £168.875, so £169.
Net saving: £5,062.50 − £168.875 = £4,893.625, rounded to £4,894 a year.
Conditions: the gift must be outright, of ordinary shares carrying full rights, and Alan must not keep control or benefit from Beth's income. A transfer between spouses living together is on a no-gain/no-loss basis for CGT, so there is no immediate tax cost.

Answer: The annual income tax saving is about £4,894, provided the gift of shares is outright and the settlements rules do not apply.

Exam tips

Read the client's objective first and write your recommendation to match it. A saving that conflicts with the objective earns little.
Always show the marginal tax rate for each person before you calculate. It makes your workings easy to follow and easy to mark.
Use the tax tables supplied in the exam. Do not rely on memory for the rates, nil rate bands, interest rates or annual allowance.
Round to the nearest £ and apportion to the nearest month, as the supplementary instructions require. State your assumptions when the question is silent.
Finish every planning answer with the saving, one risk and any anti-avoidance condition. This is where professional skills marks are earned.

Practice questions from Income tax: the use of exemptions and reliefs in deferring and minimising income tax liabilities

Income Tax Planning for Individuals and Employment Income: frequently asked questions

How can I reduce income tax by transferring income to a spouse?

Give your spouse an income-producing asset outright, such as shares or a share of jointly owned property. The income is then taxed on them at their own rates and bands. You must not keep control or a benefit, and the gift must not be of the right to income alone, or the settlements rules may tax you instead.

Which official rate of interest applies to beneficial loans in ATX?

The official rate is 3.75% in the tax tables for this exam period. Apply it to the average or actual loan balance for the period. Loans of £10,000 or less in total are exempt, and the employer also pays Class 1A NIC at 15% on the benefit.

What interest rates apply to underpaid and overpaid tax?

The tax tables give 8.50% for underpaid tax and 3.50% for overpaid tax. Apportion the interest by the months involved. Use the underpaid rate for late payments and the overpaid rate for repayments.

Is salary or dividends better for an owner-manager?

Neither is always better. Dividends avoid NIC but are not deductible for corporation tax, whereas salary is deductible but bears employee and employer NIC. Compare the total tax and NIC cost for the company and the individual, and then consider pension contributions and the client's cash needs.