Tax planning - Your personal tax
First published on 23 of November 2017 • Updated 25 of October 2018
As an individual, there are several ways in which you may have to pay tax: on your income, on investments growth, on some savings interest, and on assets you inherit. Whether you have to pay tax, and how much, can depend on a number of circumstances, so it isn’t always easy to work out what you owe. This means running the risk of either paying too little (and getting into trouble with HMRC) or paying too much, and losing money you could have kept.
Unless your tax affairs are very simple, it can be very useful to have an accountant to help you calculate your personal tax bill and also find ways to reduce it.
When do I need to pay my tax bill?
You must pay any tax you owe by midnight on 31 January following the relevant tax year. So if you are paying tax for the 2020/21 tax year, you must pay your tax by midnight on 31.01.22.
Why is tax planning important?
HMRC always says it wants people to pay 'the right amount of tax', and you should want this too. Many people end up paying more tax than they need to, because they are unaware of all their allowances and the many legal methods available for reducing their tax bill. Tax planning lets you see exactly where you are paying tax and whether you are paying too much.
The difference between tax planning and tax avoidance
Tax planning is the process of organising your finances so that you don't pay more tax than is necessary. For example, it means keeping track of all your allowances, tax-deductible expenses, charitable donations, business losses etc., while being aware of opportunities to reduce your tax bill using things like pensions and ISAs.
Tax avoidance, on the other hand, typically involves reducing your tax bill via some form of investment scheme. Many such schemes are perfectly legal, and others appear to be legal from a technical point of view. However, if HMRC concludes that the sole purpose of the scheme is to avoid tax, then it may decide the scheme is not legitimate. Many investors have used tax avoidance schemes in good faith only to find that they owe years of unpaid tax, so approach such schemes with extreme caution and seek advice.
Your self-assessment tax return
If you are on an employer’s payroll (PAYE) and this is your only source of income, then your tax will be deducted at source and you don’t have to do anything. However if you are self-employed, a freelancer / contractor, or have any other sources of income (such as rental property) then you’ll have to complete a self-assessment tax return.
If you receive notification to submit a tax return, you must do it, even if you don’t think you will owe any tax for that year. There are penalties for late submission, which are (surprisingly) more severe than the penalties for late payment of tax. Therefore even if you don’t think you can pay your tax bill, you should still submit your return on time.
Self-assessment can be daunting, and becomes more so as your finances become more complex. It’s easy to make mistakes and incur penalties, or else to err on the side of caution and end up paying too much tax. A good accountant can therefore save you money as well as time, and may charge as little as £150 for taking care of your return. They’ll also make sure it’s never late.
Here’s a summary of the different kinds of tax you may need to pay, and how each one is calculated.
There are three bands of income tax: basic rate (20%), higher rate (40%) and additional rate (45%). You start paying basic rate income tax on all income over your personal allowance (£11,850 in 2017/18 tax year) and higher rate on everything over £46,350. Additional rate is paid on income over £150,000.
If you’re self-employed you’ll be taxed on your profits – that is, your total income minus any valid business expenses. A wide range of business expenses qualify, such as travel & accommodation, staff costs, heating, lighting and rent of business premises, business rates, stock and raw materials (see the full list on the government’s website). Keep a detailed record of all such expenses and include them when submitting your self-assessment.
If you buy something for your business that is an ongoing asset (such as equipment, machinery or computers), then this is classed as a capital asset rather than an expense. Capital assets qualify for a different kind of tax relief, called capital allowances. Usually you can claim relief for up to £200,000 of spending on capital assets, though it’s possible to claim lower levels of relief (‘writing down allowances’) on spending that exceeds this.
Ask your accountant about business expenses and capital allowances and whether you can claim them to reduce your overall income tax bill.
National insurance (NI) is a special kind of tax that helps to pay for state benefits, such as the State Pension. You pay it if you are either employed or self-employed, and between the ages of 16 and State Pension age.
There are four main kinds of NI contributions, known as Classes 1 to 4. You pay Class 1 NI if you are an employee (i.e. you work for another employer), and this is paid via PAYE. If you’re self-employed and your profits are above the small profits threshold, you’ll pay Class 2 – although these are being scrapped from April 2019. If your profits are above the lower Class 4 profit limit you’ll also play Class 4.
Class 2 contributions are the same for everyone who pays them. Class 4 contributions are 9 per cent of your profits between £8,164 and £45,000, and 2 per cent of profits above that. Your accountant can help you calculate them accurately. Class 2 and 4 contributions are both payable via your self-assessment tax return.
Class 3 contributions are voluntary, for people who aren’t required to pay Class 1 or 2 but who want to keep their rights to certain state benefits. These can be paid monthly or quarterly.
Capital gains tax
If you sell (‘dispose of’) assets that have increased in value, you may have to pay capital gains tax (CGT). Such assets might include business equipment, stocks and shares, antiques or any other saleable possession. CGT is also payable when you sell property (though your main home is usually exempt) and is charged at a higher rate.
You pay CGT on the gain in the asset’s value since you acquired it – not on the total sale price. What’s more, everyone has a CGT allowance (£11,300 for the 2017/18 tax year) so you’re only taxed on gains above this level.
CGT is charged at four different rates, depending on the type of asset and on your own income tax band.
Your income tax band
Higher or additional rate
If you’re a basic-rate taxpayer, take extra care. This because your gain (minus your CGT allowance) may lift your annual income into the higher-rate band. Everything above the band will be taxed at the higher rate, while everything below it will be charged at the basic rate.
Some assets are exempt from CGT. These include your primary residence, personal possessions with a value up to £6,000, and any betting or lottery winnings. Remember too that if you are part of a couple, you can potentially save more by using both your allowances. Your adviser can help you calculate your CGT bill accurately, and also minimise the amount you have to pay.
When you die and pass assets to your beneficiaries, they may have to pay inheritance tax (IHT). This tax needs to be paid within six months of your death, which can create complications if the assets have not been released by that time. Beneficiaries may have to pay IHT out of their own assets before the estate is settled, or take out a bank loan to cover the bill.
The same applies if you inherit assets from someone else, in that you may have to pay the IHT bill before the assets are released to you. However, there are ways to plan ahead for such situations.
Inheritance is not counted as income, so you don’t have to include it on your self-assessment tax return. You can find out here about planning for IHT.
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