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Tax on extra pays

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Lump sum payments such as bonuses and back-pay are known as extra pays. The rules are designed to tax extra pays at an employee’s marginal rate.  Currently, this is calculated looking at pay over the four weeks up to the payment date. This amount is annualised and the amount of the extra pay is added. The relevant graduated flat tax rate is then found. Some employers consider this to be complex, and it is not always accurate, particularly when something unusual happened in that four week period (for example, one of the previous pays might have also contained an extra pay).

This approach could be improved by excluding any previous extra pays made in the four-week period, but then adding all extra pays made in the current tax year. Employers using payroll software will easily be able to make this calculation, but it could be difficult for those employers that use manual systems.

A simple option would be to treat extra pays in the same way as normal pay, but this would often result in too much tax being withheld.

Another option would be to calculate a rate based on average year–to-date earnings. This will be accurate late in the year, but less accurate earlier in the year. Again, this will be simpler for employers using software than for those who are not.

A way to resolve this problem might be to give employers a choice of two methods – a simple method which might suit those who use a manual system, which would be less accurate, and a more complex method which might suit those who use payroll software and would be more accurate.

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