Enter Your E-mail

Sarah Laing brings seasonal cheer with some simple tax saving ideas.

Sarah Laing

Introduction

Current speculation suggests that family finances are set to take a heavy battering in the New Year. More than one million families will face a mortgage-repayment shock next year when they come to the end of cheap fixed rates, and there are growing signs that fuel bills are set to rise too. Now is perhaps a good time to remind your clients how they can take a few simple steps to minimise their tax bill. The following tips should be a welcome Christmas present.

Personal allowances

Many people who have a partner, are married, or have children generally fail to optimise their use of personal allowances or lower tax rates. It makes sense from a tax point of view to ensure that the individual who pays tax at the lower rate (currently 22 per cent), or does not work at all, holds the savings in their name. This ensures that as a couple they pay a lower rate of tax, or even no tax at all, on their combined savings.

A higher-rate taxpayer with a buy-to-let property worth about £300,000 is likely to receive around £14,000 net rental income (after mortgage interest and other allowable deductions). The tax due on this income would be £5,600 a year. However, if his or her spouse is a basic-rate taxpayer, they could transfer half of the house into the spouse’s name. The spouse then claims half of the profits and the couple would jointly pay only £4,340. In addition, when they sell the property, they can both use the capital gains tax annual exemption.

Any money given to children by parents which earns interest will be treated as taxable on the parents, but money from grandparents will use the child's personal allowance.

Everyone is entitled to an increased personal tax allowance for the year in which they reach 65 (£7,550 for 2007/08). However, once income levels reach the annual age allowance ceiling (£20,900 for 2007/08) a much higher tax rate is effectively paid on every extra pound of income received. Those who are married, or have a civil partner, with an annual income close to the level at which age allowance is reduced should consider transferring any income-producing assets or investments to a lower-earning spouse or partner.

Income from savings such as Individual Savings Accounts and National Savings Certificates are tax free and do not count against total income for age-related tax allowance purposes.

Capital gains tax

Individuals are entitled to an annual capital gains tax exemption. The exemption is £9,200 for 2007/08, which means that it can be worth up to £3,680. Since the allowance cannot be carried forward from one tax year to the next, clients who are thinking about selling say, a bundle of shares, might consider selling some at the end of one tax year and some at the beginning of the new tax year. This will enable them to use the capital gains exemptions for two years and that could save up to £7,360 in tax.

Spouses and civil partners are also entitled to the same allowances. Assets which have built up a capital gain can be transferred between spouses or civil partners so that both annual exemptions can be used.  As with income tax, clients should try to ensure that the person paying tax at the lower rate will be the one who ends up with the taxable gains.

Losses

If you have clients who have lost money on the stock market recently, it may help soften the blow if you remind them that they can carry capital losses forward and offset them against any capital gains they may realise in future years.

Inheritance tax

Those who are married or who have a civil partner can take advantage of certain inheritance tax breaks - the transfer of assets between spouses and civil partners is ignored for IHT purposes.  Couples should ensure that they transfer assets between themselves in order to optimise the use of their nil rate band (£300,000 per individual for 2007/08). New legislation announced in the 2007 pre-Budget Report will provide greater flexibility for married couples and civil partners in this area, but unmarried couples will still need to take care, so as not to waste their individual allowances.

Clients should also consider making gifts to children or grandchildren who will be entitled to the assets free of inheritance tax as long as they survive for seven years after making the gift. In addition, the IHT gifts exemption of £3,000 a year should be utilised where possible to reduce the value of your client’s estate. An unused annual exemption can be carried forward from one tax year to the next.

VCTs

One of the best ways to cut a tax bill is to invest in a Venture Capital Trust (VCT). Broadly, VCTs are funds that invest in small, unquoted firms or shares listed on the Alternative Investment Market (AIM). VCTs can be risky but recently managers have been launching funds that limit the risks to make them more attractive. Tax relief is available at 30 per cent (even for basic rate taxpayers) on contributions to new VCT shares of up to £200,000, provided the shares are held for five years. So the maximum investment of £200,000 would render a tax rebate of £60,000. A more typical investment of £10,000 would still produce a saving of £3,000.

Clients who invest now will get a rebate against their tax bill for the current year, which is due for payment on 31 January 2009. Christmas will, however, come early for such investors because they don’t have to wait that long to claim the repayment. Once the VCT share certificate has been received a claim can be made. HMRC will adjust the PAYE tax code for those who are employed, or in receipt of a pension. The tax repayment should therefore be received via the PAYE system before the end of the current tax year.

Self-employed people can also cut the tax they owe by this January’s self-assessment deadline. Part of this will be a forward “payment on account", enabling them to offset the amount they have invested in VCTs and make an immediate saving. Those who would prefer to receive a rebate as a lump sum will have to wait until they submit this year’s tax return after 5 April 2008.

ISAs

Clients should be reminded that for 2007/08 they can save up to £7,000 in a tax-free Individual Savings Account (ISA). From 6 April 2008, this limit will rise to £7,200 and up to £3,600 of that allowance can be saved in cash with one provider. The remainder of the £7,200 can be invested in stocks and shares with either the same or a different provider. From 6 April 2008, ISA savers will be able to invest in two separate ISAs each tax year - a cash ISA and a stocks and shares ISA. Mini and maxi ISAs will no longer exist.

Since the investment limit works on an annual basis, clients should be reminded to top up their ISA savings before the end of the tax year.

Childcare vouchers

Millions of workers are missing out on substantial tax savings because they don’t sign up for their employer’s childcare vouchers. The schemes allow employees to swap part of their salary for vouchers worth up to £55 a week, which they must put towards a government-registered nursery, child minder or nanny. Where a husband and wife are working, both of them can claim.

The money is paid before income tax and NICs - a saving of about £2,100 a year if one spouse is a higher-rate taxpayer, and the other works part time and pays tax at the basic rate.

Pension contributions

Paying into a pension policy can still be one of the best ways of cutting a tax bill whilst planning for future retirement. Taxpayers and non-taxpayers alike can get tax relief on payments of up to £3,600 a year. This means that anyone can pay £2,808 into a pension and £3,600 is the amount actually invested by the pension company on their behalf.

Clients who receive bonuses should consider asking their employer to pay the bonus straight into a pension on their behalf. There will be no tax to pay and the employer will not have to pay secondary NICs on the money.

NICs

Once state retirement age is reached, currently 65 for men and 60 for women, all liability to NICs stops (although of course, employers have to carry on paying employer contributions). Clients who are over state retirement age should be reminded to check their payslips to ensure that deductions for NICs are not being made.

Mortgage repayments

Offset mortgages, which work by setting savings against borrowings to save money, account for only 10 per cent of the market even though they could save an investor more than £1,000 in tax.

Rather than earning interest on savings, the money in effect cuts the size of the overall mortgage, so the borrower pays less interest and clears the debt faster. In addition, because the borrower is not earning interest on his savings there is no tax to pay.

A higher-rate taxpayer with an offset mortgage with a fixed rate of 4.99 per cent for two years would need a savings account paying 8.3 per cent to be better off not offsetting his savings. Leading easy access savings account providers are currently only offering 6.46 per cent at best. A higher-rate taxpayer with £50,000 in such an account would pay £1,290 tax a year. By offsetting the same amount against a mortgage they would have no tax to pay.

Sarah Laing CTA is a freelance author providing providing technical writing services for the tax and accountancy profession. She is also the Editor of TaxationWeb News and may be contacted via the TaxationWeb website (www.taxationweb.co.uk).

The above article first appeared in CCH’s Taxes -The Weekly Tax News, and is reproduced with the kind permission of the author.