The Tax Band Nobody Warns You About
Most business owners know the headline tax rates. The basic rate at 20%. The higher rate at 40%. The additional rate at 45% for earnings above £125,140. What far fewer realise is that there is a hidden tax band sitting right in the middle — one that charges an effective rate of 60% on every pound earned between £100,000 and £125,140.
This is not a new stealth tax or a recent policy change. It has existed in the UK tax system since the personal allowance taper was introduced in 2010. Yet it continues to catch business owners off guard, often at the exact moment their company starts performing well enough to pay them more.
How the 60% Rate Works
Every UK taxpayer is entitled to a personal allowance — currently £12,570 of income that is completely free of income tax. This allowance is automatic. You do not need to claim it.
However, once your adjusted net income exceeds £100,000, the personal allowance begins to reduce. For every £2 of income above £100,000, you lose £1 of personal allowance. By the time your income reaches £125,140, the entire allowance has been withdrawn.
The arithmetic is straightforward but the effect is severe. On income between £100,000 and £125,140, you pay the standard 40% higher rate of income tax. But you are also losing personal allowance at a rate of £1 for every £2 earned. That lost allowance means an additional £1 of income that was previously tax-free is now taxed at 40%. The combined effect is an effective marginal rate of 60% on that band of earnings.
For a director-shareholder earning a salary of £110,000, roughly £10,000 of that income is being taxed at 60p in the pound — not the 40p they might have assumed. Over a single tax year, that is an additional £2,000 in tax compared to what you would expect at the headline 40% rate.
Why Business Owners Are Particularly Exposed
Employed workers rarely have the flexibility to control their income year to year. Business owners do. They can choose how much salary to draw, whether to take dividends, and when to trigger other forms of taxable income. This flexibility is usually an advantage — but it can become a trap when income drifts into the £100,000–£125,140 zone without careful planning.
Common triggers include:
- A bumper trading year where the director takes a larger salary or bonus to reflect the company’s performance
- Dividends combined with salary pushing total income above the threshold — dividends count towards adjusted net income for taper purposes
- Rental income or investment gains layered on top of an already-high salary
- One-off events such as selling a buy-to-let property, crystallising a pension, or receiving a distribution from a trust
The danger is that many of these events are planned in isolation. A director might discuss salary with their accountant, dividends with their financial adviser, and property income with their lettings agent — without anyone looking at the combined picture.
The National Insurance Layer
The 60% figure only accounts for income tax. If the income in question is employment income — salary or bonus — then employer and employee National Insurance contributions add further cost. For salary above the upper earnings limit (£50,270 for 2026–27), the employee pays 2% and the employer pays 13.8%. The total marginal cost of £1 of salary in the taper zone can therefore exceed 70% when all contributions are included.
This makes the £100,000–£125,140 bracket one of the most expensive income zones in the entire UK tax system — more expensive, in marginal terms, than the 45% additional rate that applies above £125,140.
Six Legitimate Strategies to Reduce the Impact
The good news is that the taper is calculated on adjusted net income, not gross income. Several strategies can reduce your adjusted net income below the £100,000 threshold, preserving some or all of your personal allowance.
1. Pension Contributions
Personal pension contributions made under relief at source receive tax relief at your marginal rate. A contribution of £25,140 into a personal pension, when your gross income is £125,140, would reduce your adjusted net income to £100,000 — restoring your full personal allowance. The effective cost of that contribution, after tax relief at 60%, would be just £10,056. It is one of the most tax-efficient uses of pension contributions available.
2. Salary Sacrifice
If your employer offers salary sacrifice arrangements — for pensions, electric cars, or cycle-to-work schemes — these reduce your gross salary before it reaches your tax return. A well-structured salary sacrifice into pension can simultaneously reduce income tax, National Insurance, and preserve the personal allowance.
3. Gift Aid Donations
Charitable donations made under Gift Aid extend your basic rate band and reduce adjusted net income for personal allowance purposes. If you already give to charity, ensuring those donations are Gift Aided can have a material tax benefit.
4. Trading Losses and Capital Allowances
For sole traders or partners, trading losses carried back or sideways against general income can reduce adjusted net income. Capital allowances on qualifying assets — particularly the Annual Investment Allowance — can accelerate deductions.
5. Timing of Income
Business owners have more control over when income is received than employees. Deferring a bonus, delaying a dividend, or spreading a property sale across two tax years can keep adjusted net income below the threshold in each year.
6. Spousal Income Splitting
Where a spouse or civil partner has unused basic rate capacity, restructuring ownership of income-producing assets — shares in a family company, rental property held as tenants in common — can shift income to the lower earner. This must be done properly: HMRC’s settlements legislation and the Arctic Systems case set boundaries around what is permissible.
The Estate Planning Connection
The 60% trap does not exist in isolation. It interacts with estate planning in two important ways.
First, pension contributions used to avoid the trap build up a fund that — from April 2027 — will form part of your estate for inheritance tax purposes. The pension pot that saves you 60% income tax today may create a 40% IHT liability tomorrow. Coordinating income tax planning with estate planning is essential.
Second, business owners who keep surplus profits inside the company to avoid personal tax exposure may inadvertently increase the value of their estate. A company with £500,000 of retained cash is worth more on death than one that has distributed those profits. If the company does not qualify for Business Property Relief — and investment-heavy companies often do not — that cash becomes part of the taxable estate.
The point is not that these strategies are wrong. It is that they need to be considered together, across income tax, corporation tax, and inheritance tax, rather than in isolation.
What to Do Next
If your income is anywhere near the £100,000 mark — whether through salary, dividends, rental income, or a combination — it is worth reviewing your position before the end of the tax year rather than after it. The strategies that work best require advance planning. Pension contributions cannot be backdated. Salary sacrifice must be agreed before the pay period. Gift Aid only counts in the year the donation is made.
Speak to your accountant about your projected adjusted net income for the current year. If it falls in the danger zone, there may be a straightforward step that saves you thousands — and protects your personal allowance for years to come.