Extra muscle required for tax band tug-of-war Published on Sunday 8 April 2012 18:27 A nasty surprise awaits middle income earners, warns Jeff Salway Thousands of middle-income Scots face being dragged into the 40 per cent tax band over the next 12 months under changes that accelerated with the start of the new tax year yesterday. The number of people paying tax at 40 per cent will reach five million in 2014, according to the Institute for Fiscal Studies, up from 3.7 million last year. It estimates that 15 per cent of taxpayers will be in the higher rate band next year, compared with 5 per cent at the end of the 1980s. The sharp increase is due primarily to a cut in the basic rate tax threshold. The threshold fell £630 to £34,370 yesterday, with income tax charged at 20 per cent below that level and at 40 per cent between the new threshold and £150,000. The lowering of the basic rate tax band offsets a rise of the same amount in the personal allowance for under 65s (to £8,105 for the 2012-13 tax year), as announced in the Budget last year. Under measures announced by Chancellor George Osborne in the most recent Budget, however, the point at which higher rate tax is charged will be lowered again next year. The basic rate limit will fall by a further £2,125 to £32,245 on 6 April 2013, taking the 40 per cent tax threshold down to £41,450 once personal allowances are taken into account. Stephen Hall, a wealth manager at Cornerstone Asset Management in Edinburgh, said: "It's not just City bankers and lawyers who are being pulled into higher rates of tax: a growing band of people earning relatively modest sums of money are facing the threat of higher-rate tax due to a sinister phenomenon called "fiscal drag" - whereby tax bands fail to rise at least in line with inflation." However, if you are on the cusp of the limit there are ways of ensuring you do not have 40 per cent taken off the top slice of your income. The same measures may also help mitigate the potential loss of some or all of your child benefit from next year, if you are among those families with at least one earner on £50,000 or more. Perhaps the most effective way to remove yourself from the 40 per cent firing line is to boost your pension contributions. By doing this you are effectively expanding your basic rate tax band and offsetting the changes coming into force. For instance, someone earning £45,000 is paying 40 per cent tax on the amount above the £42,475 threshold, which has been frozen at the 2011-12 level and will come down to £41,450 next year. By paying £250 a month (£3,000 a year) into a pension, however, you are doing enough to stay out of higher rate territory. And that is before tax reliefs are factored in, Hall pointed out. Contributions are automatically granted basic rate relief and, so are currently paid net of 20 per cent. An £80 a month net pension contribution is, therefore, grossed up to £100 in the pension," he said. You can boost your workplace pension payments through salary sacrifice, where you agree with your employer to reduce your taxable income by diverting your earnings into other benefits. This is usually done in exchange for the employer paying more into your pension. If you earn £42,000 a year, you face being pulled into the 40 per cent band next April when the threshold falls to £41,450, so sacrificing £1,000 and having that paid into your pension instead will keep you below it. Donations to registered charities are another way to combat the drag into the higher rate band. Anna McBride, senior tax manager at Grant Thornton, explained: "For each £1 that is paid to an approved charity, an additional £1.25 is added to the basic rate band of tax, thus reducing the amount of income that is payable at 40 per cent by this amount." Make sure you tick the gift aid option to ensure the charity can reclaim a further 25p of each £1 donated. Closer to home, if you're married or in a civil partnership and one of you is in the higher bracket, you could transfer income-producing assets between you to reduce your liability, as the rate of tax you pay includes investment income as well as earnings.