01: Basic income tax planning for you

There are a number of fairly straightforward ways in which individuals can reduce their tax liabilities.

However, you should never forget that tax is not the only consideration. For example, an investment might have tax advantages but be a poor investment. And transferring investments to a spouse might reduce tax on the income that is generated but might cause difficulties if the marriage breaks up. Income tax planning should also take into account the effect on other taxes, such as capital gains tax and inheritance tax.

Basic income tax planning is likely to cover the following areas:

  • If you are in a position to control the timing of your income, for example, you are a director-shareholder, you should try to ensure that your personal allowances and basic rate tax band are not left unused in one tax year while your income is taxed at higher rates in another year.
  • Some couples find that one spouse pays higher rate tax, while the other does not have enough income to use up the whole of the personal allowance and basic rate tax band. There are several ways of transferring income between spouses:
    • If you are in business, you could employ your husband or wife at a salary, provided it can be commercially justified for the work carried out. You may have to deduct tax and national insurance under PAYE.
    • The business could also make employer’s pension contributions for the employed spouse.
    • You might be able to run a business in partnership and share your profits equally. Both of you must genuinely be involved in the business.
    • A couple could jointly own an incorporated business, so that you can both receive dividends from the company. The tax credit on the dividend cannot be recovered, so you would both need some other income to benefit from your personal allowances.
    • In some circumstances HMRC has tried to use complex anti-avoidance legislation to tax dividends paid to a non-working spouse as if they had been paid to the spouse working in the company (and generating its profits). It is therefore important to take especial care in this area.
    • Married couples can transfer assets between one another free of capital gains tax, so they could ensure that investment income arises in the hands of the individual who will pay less tax on it. Registered same-sex couples will be able to do likewise. Alternatively they could hold investments jointly.
  • Where possible, it is worth claiming tax deductions in the years for which they give rise to tax relief at the highest rates. For example, if you have a fluctuating income so that in some years you are a higher rate taxpayer and in others you are a basic rate taxpayer, it may be worth contributing to a pension scheme in those years in which you pay more tax.
  • You should undertake major expenditure that qualifies for 100% capital allowances, such as on qualifying flat conversions, or make full use of the 100% annual investment allowance of £50,000 in those years when your tax rate is highest.
  • You should remember that you can suffer high marginal rates of tax on allowances and tax credits that are withdrawn gradually once your income exceeds a specified level. Examples include age allowances, and child tax credits. The high marginal rates increase the value of any tax reliefs that your reduce income within the withdrawal band. For example, if you are entitled to age allowance, but you have dividends of £2,000 above the age allowance limit, you could pay a pension contribution and benefit from an effective rate of tax relief of 30%. This is because your age allowance will be reduced by £1 for every £1 that your income is above the age allowance limit.
  • Most individuals aged under 75 can pay up to £3,600 gross into a personal pension plan and obtain tax relief at 20% regardless of earnings. You could fund pension payments for a non-earning spouse and even for children.

There are many other opportunities for tax planning depending on your circumstances and the types and sources of your income.
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