Back to school – know your income tax (part 1)
The kids have gone back to school, but one thing they won’t learn about there is income tax. An alarming number of people in the UK still don’t understand all the ways in which they’re taxed. IFA Ajay Naik of Bankfield makes it his mission to help clients save money in this oft-neglected area.
If you don’t know how something works, you’ll struggle to make the best of it. When that thing is income tax, the result is that you lose money. I’ve put together a two-part primer for anyone who wonders if they might be able to reduce unnecessary tax. If you don’t fully understand income tax, read on. If you think you do fully understand it… still read on.
The basics of income tax
We’ll start with the things you may know already. Even so, there may be details you’re not aware of.
Income tax is charged against your worldwide income unless you are not domiciled in the UK. You are entitled to offset your total income against a personal allowance; for 2015/16 this is £10,600 (it generally rises every year). Only the income over the annual allowance is taxable, and that rate varies by the total income you have after taking off the personal allowance. The rate and thresholds also change year by year.
For most people, income tax is paid throughout the year as a deduction from wages and salaries under the Pay As You Earn (PAYE) scheme. The monthly calculations are driven by your tax code, and the standard code for 2015/16 is 1060L. If your tax code is not 1060L, you need to know why; HMRC should have told you what yours is on a form P6 or P9. Often the letters on the end of the tax code will give you a clue, but there is no guarantee that either the code or the letters are correct. It’s your responsibility to query any discrepancies. If your tax code is wrong, then the tax taken will be wrong and will stay wrong until you do something about it. Paying too little tax can be even worse than paying too much, as HMRC may add penalties if they believe they were deliberately misled.
If you do not pay tax by PAYE (e.g. if you are self-employed or have multiple sources of income) you will have to send in a tax return each year. Generally HMRC will make this request to you by letter, but if your tax affairs change significantly during the year you ought to file a return even if not asked – HMRC will view non-disclosure in a poor light. If you are really unlucky, they will conduct a full investigation into your tax affairs, costing you a great deal in time, effort and (potentially) money.
Tax returns are all filed online, so you will need an online ID and the access codes to the HMRC website. Do not leave this to the last minute, as there are fines for late filing. If your tax affairs are complex, it is highly recommended that you hire an adviser (a financial adviser or an accountant) to take care of your tax return, as they can avoid errors and probably save you money at the same time.
- Make sure your tax code is correct; get this wrong and everything is wrong.
- Keep your payslips, notices of coding, P60s, P45s and statements of taxable income from your bank, building society and dividend warrants.
- Remember to claim for allowable expenses, like professional membership fees, tools of the trade, personal protective equipment, allowable business mileage and business telephone calls.
- Make pension payments, maximising any employer contributions.
- Join any Sharesave or Save As You Earn (SAYE) schemes offered.
- If you have a problem with paying tax or think the tax demanded is incorrect, you must contact HMRC – left to itself, the problem will only get worse.
In part two: the most common reasons for paying too much in income tax.
Ajay Naik (based on an original article by Jeremy Edwards).
About the author
Ajay Naik is an IFA and Financial Planning Director at Bankfield. Winner of Institute of Directors ‘Director of the Year Awards’ in 2014, Ajay has earned a reputation within the business and professional community as one of the most energetic and focused young entrepreneurs and business leaders in the East Midlands. He specialises in building and managing the wealth of business owners and has contributed to the success of many enterprises across the UK.