Your marginal tax rate is not a blanket rate

AS AN individual taxpayer, you will be aware of the marginal tax brackets – from 0% through 18%, 26%, 31%, 36%, 39%, 41% to 45% – that apply to taxable income.

If, for example, your income is R400 000 a year, you’re within the R321 601 to R445 100 band for the 2020/21 year, and your marginal rate is 31%.

However, it is a common misconception that this percentage is applied to your entire income; the 31% rate applies only to the last “stepped” portion of it.

A useful metaphor for understanding how this works is to think of the bands in the South African Revenue Service (Sars) tax table (as published on its website) as rising water encroaching on a basement staircase about to be flooded, where the rising level represents your income creeping higher up each successive step, says Kobus Kleyn, a Certified Financial Planner with the Financial Planning Institute of South Africa and a tax practitioner with the South Africa Institute of Taxation.

“The lowest step, up to R83 100, which isn’t reflected on the Sars table, is in effect a 0% tax band, thanks to the ‘primary rebate’ for all taxpayers. The rebate amounts to R14 958 for the 2021 tax year. This is built into everyone’s income, so technically you don’t pay tax on this portion.

“The more income you earn, the higher your taxable income will rise over each step (like rising water). The highest marginal rate of income tax is only applicable on the final stepped portion of your income, where it levels off (or ‘margins’ off) at a particular step. In other words, the highest tax only applies to the top step, while lower tax percentages apply for each of the lower steps down to the 0% band,” Kleyn says.

However, determining what you owe Sars is still not as simple as this. Kleyn says the determination of tax payable follows a set order, with different deductions and rebates applied at various points in the calculation.

“First, your ‘gross income’ increases with investment interest income (above the annual tax-exempt thresholds), and dividend and real estate investment trust (Reit) income from discretionary investments. Any net capital gains are also added, where applicable.

“Thereafter various deductions are considered, such as employer retirement fund contributions (which have already been factored into your remuneration), your own retirement fund contributions, business travel expenses and donations to charities. For those who work on commission, all business-related expenses incurred in the production of this income are included here.”

At this point you have reached a figure that is termed “taxable income”, says Kleyn, and the rates of tax according to the Sars table for individual taxpayers are calculated on this amount.

Last, the rebates are applied. These include the previously mentioned “primary rebate” for under 65s and further age-dependent secondary and tertiary rebates that are factored into pension-annuity income for pensioners. The final step in the calculation is to apply the medical rebates.

“Once the final tax is known, it can be expressed as a percentage of gross income, known as your ‘average’ rate of income tax,” says Kleyn. “An individual below the age of 65 earning R400 000 gross a year in the 2020/21 tax year will pay tax of R76 490, which is 19.1% ‘average tax’, through all the bands or steps leading up to the 31% bracket.” Note that it takes all the various rebates and deductions into account.