Time is right to take steps to keep the taxman’s bill to a minimum

With a double-dip recession on the horizon and the government struggling to balance the books, we’re set for a taxing 12 months.

This time last year shoppers were rushing to take advantage of lower VAT, before it was hiked from 17.5 to 20 per cent. Today, even the big supermarket chains are floundering amid soaring prices.

Inflation, as measured by the retail prices index (RPI), stood at 5.2 per cent in November – way above the government’s target of 2 per cent.

With average salaries rising by just 1.7 per cent, according to Office for National Statistics figures, consumer spending power is being seriously eroded.

Add to this the government’s continued ambitious plans to significantly reduce the nation’s debt, and it’s clear that we will all pay more tax and see our real standard of living squeezed.

Thankfully, there are steps that you can take to reduce the amount of money you hand to the taxman. Here’s a ten-step plan to paying less tax in 2012:

• Check your tax code

Up to a quarter of all pay-as-you-earn (Paye) codes are incorrect when issued, so make sure you’re paying the right amount of tax. If you think you’re paying too much, seek guidance and reclaim any overpayment from HM Revenue & Customs (HMRC). If it thinks you haven’t paid the right amount of tax in a particular tax year it will send you a tax calculation known as a P800. If you get one, double-check the details of your employment income and benefits and tell HMRC of any errors.

• Allocate assets correctly

It’s very common for married couples to hold savings accounts in join names, mainly for convenience. If one party is a 40 per cent taxpayer and the other a non-taxpayer, income is taxed at 20 per cent. However, by putting the account solely in the non-taxpayer’s name, interest would be tax-free.

• Use basic rate tax expanders

The personal allowance will increase to £8,015 in 2012-13, but the basic-rate tax limit will fall from £35,000 to £34,370. This means that the higher rate threshold remains static, kicking in above £42,385.

If you’re a 40 per cent taxpayer you’ll lose any entitlement to child benefit from 2013. A family with one child stands to lose £20.30 per week or £1,055.60 a year, while a family with two children will be a whopping £1,752.40 worse off.

If you narrowly breach the higher-rate tax threshold, making a pension contribution or donation to charity via gift aid in this tax year are two ways to expand your basic-rate tax band. It could make the difference between receiving a full year’s child benefit or not.

• Beware the 60 per cent tax band

April 2010 saw the introduction of the 50 per cent tax rate and the removal of the personal allowance for high earners, with a reduction of £1 for every £2 of income over £100,000 – giving an effective tax rate of 60 per cent on income between £100,000 and £114,950.

Expand your basic-rate tax band to increase your starting threshold for this tax. One popular way is to make a lump sum or higher regular pension contributions.

• Use unused pension allowance

Regardless of your income, you and your employer can contribute up to £50,000 a year to your pension pot, under recent changes to pensions legislation. This can be extended by carrying forward any unused relief from the previous three tax years. If you’ve been dissuaded from putting anything into your pension recently, you could stash away £250,000 with full tax relief – £50,000 of allowance for 2011-12, £150,000 of unused allowance from the previous three years and £50,000 allowance for 2012-13.

Tax relief is here now, but with the government’s finances in disarray, who knows what the future holds? Boost your pension savings and grab extra tax relief while you can.

• Start a spouse’s pension

The spouse with the largest income often puts money into a pension during their working life. However, with the personal allowance for a 65-year-old at £10,500 in 2012-13 (up from £9,940), there’s little point in reaching retirement and having £20,000 of pension income in one name; far better for both husband and wife or civil partners to have £10,000 each, saving more than £2,000 in tax per year.

Non-working partners can pay £3,600 into a pension each year and still get tax relief, so the net cost is just £2,880.

• Use higher Isa allowance

The maximum annual amount that can be invested in an individual savings account (Isa) will increase from £10,680 to £11,280 on 6 April. Up to half (£5,640) can be squirreled away in a cash Isa, with the remainder in a stocks and shares Isa, or the entire allowance can be used in the latter.

• Realise capital gains

The capital gains tax (CGT) allowance of £10,600 can’t be carried forward. If you’re fortunate enough to have made some, realise gains up to this value by selling or switching assets – for example, a share or unit trust portfolio – and sheltering them in a more tax-efficient environment, like a pension or an Isa.

Higher-rate taxpayers pay CGT at 28 per cent, while basic-rate taxpayers pay 18 per cent, so there’s merit in transferring assets between spouses, even if gains are over the allowance. The 10 per cent difference equates to a saving of £1,000 per £10,000 of gains.

If you’ve made losses, you might want to realise these too. Losses can be carried forward indefinitely and offset against future capital gains – perhaps when your CGT rate is higher.

• Plan for IHT

Inheritance tax (IHT) is normally charged at 40 per cent on anything over the “nil rate band” of £325,000 per individual or £650,000 per married couple.

However there are several ways to reduce your liability. You can give away £3,000 a year IHT-free; £5,000 to children and £2,500 to grandchildren when they get married; and £250 to any number of recipients in any tax year. Donations to charity are also exempt, as are unlimited gifts out of income, provided these don’t reduce your standard of living.

Larger gifts can be made, but you have to survive at least seven years to make them IHT-free, so plan ahead.

• Don’t let the tax tail wag the dog

The junior Isa, introduced in November, allows £3,600 a year to be saved tax-efficiently for any child that doesn’t have a child trust fund in their name.

By age 18, a massive £64,800 could have been contributed. Assuming an annualised growth rate of 5 per cent a year, a £103,500 pot of cash could fall into the hands of a maturing teenager.

If you feel uneasy about your child having control of such a large amount, think of other ways to save for them. If you’re not using your own Isa allowance, earmark contributions for your child. Although not as tax efficient, collective investments offered by fund managers give better parental control and allow for higher contributions.

• Jason Hemmings is a partner at Edinburgh-based Cornerstone Asset Management