Income tax - the most common of all taxes, is the tax you pay on your personal income. It forms the bulk of revenues collected by the national government (HMRC) to pay for services used by the state - such as education and healthcare. Depending on your form of income, HMRC deducts income tax in various ways - the most common being deductions through the PAYE (pay-as-you-earn) system.
Although income tax is a necessary evil, it is possible to reduce the amount you pay. Here are some legitimate ways you can use to avoid paying too much income tax:
- Make additional pension contributions:
Paying into a personal or employer’s pension scheme is the simplest way to minimise your income tax burden. The government encourages you to save for your retirement by giving you tax relief on pension contributions. You can currently contribute up to £50,000 each tax year into a pension. You pay Income Tax on your earnings before any pension contribution, but the pension provider claims tax back from the government at the basic rate of 20%. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot. If you pay tax at higher rate, you can claim the difference through your tax return or by telephoning or writing to HMRC. If you're an additional rate taxpayer you'll have to claim the difference through your tax return.
- Charitable donations:
Giving money to charities under the Gift Aid scheme provides reliefs from tax. Relief is also available for gifts of land or quoted shares to charity and for donations deducted from your salary through your employer’s payroll. Depending on the type of gift you make, you may have to make a claim to receive the tax relief (either on your Self Assessment tax return or by contacting your own Tax Office).
- Incorporate your business:
With Corporation tax rates reduced to a maximum of 23% you can consider incorporation to mitigate tax on your profits at corporation tax rates, rather than suffer an income tax rate of 45%.
- ISA allowances:
Though ISAs are not considered as the best tax planning suggestion, they do allow you to build up a significant tax-free fund. You can invest up to £5,640 into cash and deposits. You can invest up to £11,280 into a stocks and shares, restricted to £5,640 if you have already utilised your cash ISA allowance too.
If you are self-employed and if you have made a loss from one year's trading, it maybe possible to carry forward the loss, and offset it against profits from the next period. Thus, keeping more cash available. Loss relief may also be available to utilise against prior year’s or current year’s income, depending on your circumstances.
- Joint bank account:
For more tax relief, open a joint bank account with your spouse or partner and also earn interest on it.
- Rent a room:
If you rent a room of your house you can receive up to £4,250 in rent without paying a penny to the taxman.
- Property allocation:
Allocate property to spouse or partner will help you reduce your tax bill.
Ensure that dividends don’t exceed the basic rate threshold otherwise you have to pay an effective tax rate of 25% in addition to the corporation tax charged on profits.
- Pay your spouse:
If you appoint your spouse as a director or company secretary you can claim a minimum wage. If done correctly, it may even count towards their pension entitlement.
In order thoroughly understand income tax and make the right choice for your circumstances, it is important to talk through your options with an independent, professional accountant. Also it is important to check the accountant's qualifications and areas of specialism.
The article is for general information only and is not intended to be investment, tax or legal advice to any specific person. You should not rely on this information solely to make any decisions. Always obtain independent, professional advice for your own particular circumstance.