The former Labour Party Chancellor of the Exchequer, Roy Jenkins, once described Inheritance Tax (IHT) as “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.” Whilst I firmly believe IHT is largely a voluntary tax and one that is fairly easy to avoid legitimately, Income Tax is far more challenging to prevent. Having said that there remain a number of easy ways to reduce the impact of Income Tax in the UK.
Many taxpayers in the UK fail to claim higher rate tax relief on their pension contributions. When you contribute to a pension scheme you usually pay the amount net of basic rate tax relief at 20%. So in other words for every £100 you pay the government tops it up by £25 meaning you have paid a £125 gross contribution. However, if you are a higher rate (40%) or additional rate (45%) taxpayer, you have to claim the balance of 20%/25% usually via your Self Assessment Tax Return or by tax code change (see below). As you only have four years to claim it from the end of the tax year of your pension contribution do not delay in making your claim!
Charitable gifting is easy these days, especially through the Gift Aid Scheme. Charities and Community amateur sports clubs can claim an extra 25p for every £1 you donate.
If you are a higher or additional rate taxpayer you can claim further tax relief in much the same way as you do for pension contributions (see above).
Maximising personal allowances
The personal tax allowance is £12,570 for 2022/23. If your income is more than £100,000 your allowance reduces by £1 for every £2 that your income is above £100,000. Your allowance becomes zero once your taxable income reaches £125,140.
So if you are a married couple or civil partners, and only one of you earns more than £100,000 a year, consider transferring income producing assets e.g. investments or properties into the lower earner’s name.
Married couples and civil partners can take advantage of the ‘Marriage Allowance’ and apply to transfer 10% of their income tax personal allowance from one to the other, i.e. £1,260. Depending upon their individual tax situation, the tax saving will be up to 20% on this allowance i.e. £252 maximum. Qualifying conditions apply.
Dividend allowance and personal savings allowance
Your dividend allowance is the amount you can earn tax-free from dividends. The allowance is currently £2,000 and is in addition to your personal allowance of £12,570. Any excess of dividends above £2,000 will be subject to dividend tax which is calculated at three different rates like Income Tax.
You’re allowed to generate a certain amount of income from the interest on your savings each year.
- Basic-rate taxpayers can earn up to £1,000 in savings interest for 2022-23
- Higher-rate taxpayers can earn up to £500 in savings interest for 2022-23
- Additional rate taxpayers will not have a personal savings allowance.
Most people are entitled to an Income Tax-free allowance of £12,570 a year. This is the amount of money you can earn in a tax year before you pay any Income Tax. So if you are employed your tax code is usually 1257L. In other words, it is the amount of your income tax allowance minus the final zero.
Your allowance can be reduced or increased for any number of reasons. For example, you may have untaxed income from another source or you may have a tax deduction due from a pension contribution. If your personal allowance is not 1257L and you are not expecting it to be different then you should check it, get someone else to check it or contact HMRC to query it.
Many people don’t question their tax code because the tax coding notice is quite confusing. However, it could be costing you dearly if you fail to question it.
An income tax charge applies where taxpayers receive child benefit and one or both of them has an adjusted net income over £50,000. For married couples, civil partners and couples living together who both have income above £50,000, the one with the highest net income will receive the tax charge.
A charge of 1% of the child benefit amount is applied for each £100 of adjusted net income over £50,000, and the benefit payment is effectively reduced to nil where adjusted income reaches £60,000. Making pension contributions or charitable donations to reduce adjusted net income (as above) can see a child benefit tax charge reduced or removed completely.
Your employment status can make a huge difference to your tax position. Generally, there are significant advantages to being self-employed but there are some disadvantages. So it is important to get professional advice, especially from an accountant.
If you are employed you are subject to PAYE which means that you pay higher National Insurance. Additionally, you are able to claim less tax reliefs and allowances as an employee as opposed to a self-employed person. On the other hand, you have greater employment protection and more benefits than a self-employed individual.
If the disadvantages of self-employment do not deter you then self-employment’s many advantages may be preferable to you. For example, subcontractors usually earn much higher rates of pay than employees. However, it is much harder to be a self-employed subcontractor these days due to changes in HMRC’s taxation rules for employers.
Maximise employee benefits
Check what benefits your employer offers and especially take advantage of the most tax-efficient ones such as the following perks:
- Employer pension contributions
- Life insurance
- Company electric car
- Salary sacrifice
The first two perks are completely free of tax benefits in kind. A company electric car with zero CO2 emissions is subject to just 1% benefit in kind taxation, rising to 2% next tax year. It is based on the value of the car when first registered.
Your employer may offer salary sacrifice, especially for pensions. This involves the employee giving up a certain amount of salary in exchange for their employer paying this amount into the employee’s pension. Most employers will add the National Insurance saved to their contributions.
Each individual adult can invest up to £20,000 each tax year into an ISA (Individual Savings Account). By ISA I mean a Stocks and Shares ISA, not one issued by a bank which is known as a Cash ISA. The advantage of ISAs is that they are free of Income Tax and Capital Gains Tax. Married couples and Civil Partners can invest £40,000 (£20,000 each) and children can invest £9,000 in Junior ISAs annually.
VCT, EIS and SEIS
VCTs (Venture Capital Trusts), EIS (Enterprise Investment Schemes) and SEIS (Seed EIS) offer significant Income Tax savings as well as other potential tax savings. However, they are high risk investments so you should always take professional advice before investing in such investments.
So there you have it. 10 easy ways to save Income Tax. You really should take advantage of these tax tips. You know it makes sense.*
*VCTs are high risk investments and there may be no market for the shares should you wish to dispose of them. You may lose your capital.
Enterprise Investment Schemes (EISs) are very high-risk investments. An EIS investment is usually concentrated in one single unquoted trading company. Often there is no market for the shares and it may therefore be very difficult to make a disposal. There is a strong possibility of the chosen company failing.
The value of your investment can fall as well as rise and is not guaranteed. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.