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26 April 2013

Calculation of tax

One of the more common questions that an accountant is asked is "how much can I earn without paying tax?"

Whilst the question is relatively straightforward, the answer is essentially "it depends."

This aim of this post is to give a very basic overview of how your tax bill is calculated, with details to come in later postings.

1. Work out your taxable income according to type of income e.g. Self-employment, salary, interest, dividends etc. Don't forget to deduct legitimate expenses first.

2. Certain non-business expenses are allowed, at least in part, by the tax authorities. E.g. Disability insurance, payments to Bituach Leumi (certain circumstances only) and some pension contributions. These deductions also need to be attributed against the types of income.

3. Once you have the final taxable income, you can calculate the gross tax payable.

Earned income (e.g. salary) is taxed at rates starting at 10% and going through 14%, 21%, 31%, 34% and up to 48% for (total) incomes over NIS 501,960 per annum.

Unearned income (e.g. rent, interest) is taxed similarly, but the first three bands are not given, i.e. the rates start at 31%. The unearned income is taxed after the earned income, so if you reach the 34% bracket with your salary, your unearned income will continue from there, and not go back to the start of the 31% bracket.

However, the law limits the tax rate to certain percentages in certain situations. The most common of these are interest (25%), dividends (25% or 30%) and capital gains (25% or 30%).

Additionally, anyone earning in excess of NIS 811,560 in 2013 (cumulative for all sources of income) is subjected to a 2% surtax on the excess.

4. Against the gross tax payable, you can offset credits. These reduce your tax bill, but will not result in a refund if your credits exceed your gross tax liability.

Credits fall into two broad categories - those based on personal circumstances (dealt with via the "points" system) and those based on certain payments made during the tax year. A fuller treatment of credits will come later (בלי נדר).

5. If you paid foreign tax on any of your Israeli-taxable income, you need to calculate how much foreign tax credit you can claim against the Israeli income. Again, a fuller treatment will be forthcoming in a later blog.

6. Finally, there are certain types of income for which no other credits are given. So your final tax bill will always include the tax on these sources regardless of your credits. We will cover these in their appropriate places.

So there you have it. A very basic outline of how your Israeli income is calculated, and how much you can earn before paying tax depends on (at least), what type(s) of income you have, where it is earned, and how many credits you are eligible for.
None of the above takes into account liabilities for Bituach Leumi - but that's a different story altogether.

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