17 February 2023
At this time of year, we should all review our personal tax affairs to make sure that we use the allowances and reliefs offered by the tax system. Many of these are lost if not used each year, so with 5 April only weeks away, action is required now in order to benefit. However, some reliefs can create problems if you are not careful, and in some cases trying to save tax can actually cost you money.
Personal allowance and capital gains tax exemption
The annual income tax personal allowance for 2022/23 is £12,570, so income of this amount can be received free of income tax. If you have family members with less income than this, consider possible ways to utilise their allowance – paying dividends above their dividend allowance or salaries (so long as actual work is performed) and trust income distributions are all worth thinking about where those options are available.
£1 of the personal allowance is lost for each £2 of income received above £100,000. This creates an effective marginal tax rate of 60% on income between £100,000 and £125,140. Managing the timing of income between tax years, where possible, can help – the tax payable on income of £100,000 one year and £150,000 the next is less than the tax on income of £125,000 a year for two years.
Similarly, the capital gains annual exemption allows up to £12,300 of gains to be realised without tax. If you have not already made gains of this amount, consider selling assets standing at a gain to take advantage, but remember that you can no longer ‘bed and breakfast’ chargeable assets. For example, if you repurchase shares in the same company within 30 days of selling them, the two transactions will be treated as cancelling each other out, so you either need to invest in other assets or wait 31 days to buy them back.
Relief for pension contributions
If your qualifying earnings are no more than £240,000 in the tax year, the maximum annual pension allowance is £40,000. For higher earners the allowance is reduced as income increases, to a minimum of £4,000. In addition, unused allowances from the previous three years can also be set against current year contributions.
Be careful though – if the value of your pension fund is more than your lifetime allowance (currently £1,073,100), a 55% tax charge can arise on the excess.
Charitable donations qualify for tax relief by extending the donor’s basic rate tax band. The mechanics can be confusing, but the net effect is that if a 40% taxpayer makes a cash donation of £100, the charity receives £125 and the individual can personally claim back tax of £25.
There are some traps to watch out for when making charitable gifts. If you make a donation under Gift Aid and have not paid sufficient tax to match it, your tax liability will actually increase - a Gift Aid payment of £100 by a non-taxpayer will actually make them liable to pay tax of £25. Not all donations qualify for tax relief either. For example, a gift to a US charity will not be allowable, but a gift to a UK charity created to support the US charity would be. Make sure that you check before donating that your payment is going to the right entity or else both you and the charity will miss out on relief.
Taxpayers have a £3,000 annual gift exemption, which can be carried forward one year. This means that you can make gifts of up to £6,000 every other year without suffering inheritance tax if you do not survive the gift by seven years. If you do live for seven years after the gift, inheritance will not be payable regardless of its size, so giving away unneeded wealth while you are healthy is worth thinking about.
If your income is greater than your living expenses, you may also be able to make larger gifts that will not be taxed regardless of when you die. To qualify, these must form a regular pattern of giving and should be properly documented. You should take professional advice before proceeding with such a strategy.
EIS and SEIS allowances
Tax relief is given for qualifying investments in certain trading companies under the enterprise investment scheme (EIS) and seed enterprise investment scheme (SEIS) rules, where the company has obtained approval from HMRC. Income tax relief at 30% (EIS) and 50% (SEIS) on the amount invested can be attractive, as well as exemption from capital gains tax on disposal and the possibility to roll over (EIS) or partially exempt (SEIS) capital gains on other assets reinvested into such investments.
Watch out when making these investments though. To qualify for capital gains tax exemption, you must have claimed income tax relief on the EIS or SEIS investment. For example, if you make an EIS investment in a year when you have no income tax liability, the gain made on disposal of that investment will be taxable. When making investments in qualifying EIS or SEIS shares it is therefore important to think about your taxable income overall, and if your income is not high enough to use the available income tax relief in full, consider whether you can create more, for example by changing the timing of paying salary or bonus if you are able to do so.
The UK tax system actively encourages taxpayers to plan and act each year to use the available reliefs and allowances. Doing so can create substantial savings but care is required to make sure that your actions do not backfire, creating larger tax liabilities than they save.
For more information, please get in touch with Andrew Robins or your usual RSM contact.