Six easy ways to legally pay less tax

New research by professional advice website unbiased.co.uk claims we’ll collectively gift the taxman £12.6 billion, or £421 per taxpayer, this year.

The company’s annual Tax Action report highlights 10 examples of tax wastage, either benefits we’re not claiming or tax breaks we’re not using.

The biggest area of wastage the report highlights is income-related tax credits, which include Child Tax Credits, Working Tax Credits and Pension Credits.

Failing to take advantage of the tax relief available on pension contributions is the second biggest waste, with not using tax relief on charity donations third.

Here’s the top 10 list of our biggest tax wastes:

Area of Tax Wastage	Amount of Wastage
Income-related Tax Credits	£7.26 billion
Tax relief on pension contributions	£2.45 billion
Tax relief on charity donations	£997 million
Savings on Inheritance Tax	£448 million
Making use of ISAs	£403 million
Child Benefit	£401 million
Avoiding penalties for late filing of tax return	£307 million
Savings on Capital Gains Tax	£133 million
Making use of Employee Share Schemes	£118 million
Income tax and Personal Allowances	£83 million
Total	£12.6 billion

Source: unbiased.co.uk

So now you know where you’re paying tax unnecessarily, I’m going to show you six ways you can stop wasting your money and pay less tax.

1. Get an ISA

One problem with saving money in a standard savings account is that you have to pay tax on any interest you earn on those savings. And with interest rates so low on many savings accounts right now, this really is the last thing we all need.

So to avoid this, make sure you invest in an ISA. This is a tax-free way of saving and you can invest up to £10,680 in an ISA each tax year. You can invest the full amount in a stocks and shares ISA, or you can split your investment between a cash ISA (up to £5,430) and a stocks and shares ISA.

You can also stash tax-free cash for your children by opening a Junior ISA (up to £3,600 during the current tax year) or by saving into an existing Child Trust Fund (the savings limit on these have now been raised to £3,600 a year in line with the Junior ISA limit). Or you could consider starting a pension for them.

[Related link: Compare ISAs online]

2. Use your pension

By using a pension to save for retirement, you’ll also avoid paying tax. That’s because your pension contributions qualify for tax relief. So if you’re a basic rate taxpayer, you’ll qualify for tax relief at a rate of 20%. Meanwhile, higher rate taxpayers qualify for tax relief at a rate of 40% and additional rate taxpayers will get 50%.

So pensions are a great way to build up a tax-free nest egg for your retirement. That said, once you start to claim your pension income, you will have to pay income tax.

You should note that the amount you can contribute to your pension tax free is now limited to £50,000 a year.

3. Use your partner

If you’re a taxpayer, but your partner isn’t, a great way to save tax is to transfer any income producing assets to his/her name and receive the lower tax rate by using his/her personal allowance. Your personal allowance is the amount of money you can earn before having to pay tax.

The table below shows the personal allowance for the current tax year and next: 

Personal allowances	2011/2012	2012/2013
Personal allowance	£7,475	£8,105
Allowance for those aged 65-74	£9,940	£10,500
Allowance for those aged 75+	£10,090	£10,660

4. Check your tax code

Your employer uses a tax code to calculate how much tax should be deducted from your pay. But how many of us actually bother to check our tax code to see if it’s correct?

Your tax code is made up of a few numbers and a letter. If you multiply the numbers as a whole by 10, that’s how much money you can earn before you start paying tax. The most common number is 747, as for most people it’s only once you earn more than £7,475 that you start paying tax.

Meanwhile, the letter refers to your tax status and how that affects the preceding number. The most common letter is L, meaning you qualify for the basic personal allowance. You can find out more about all of this on this page of the HM Revenue & Customs site.

If you check your tax code and you think there’s been a mistake, you need to contact your tax office.

5. Be careful what you give

In each tax year, you can gift up to £250 to as many people as you like, completely free of inheritance tax. Just bear in mind you can’t give a larger sum of money and claim exemption for the first £250.

You can also give away £3,000 in total each tax year and if you don’t use your full allowance, you can carry it over into the next tax year. However, you can’t combine this £3,000 allowance with a £250 gift to the same person.

Wedding or civil partnership ceremony gifts are also exempt from inheritance tax – although there are limits to this:

• Parents can each give cash or gifts worth £5,000

• Grandparents and great grandparents can each give cash or gifts worth £2,500

• Anyone else can give cash or gifts worth £1,000

However, you will need to give this gift (or promise to give it) on or shortly before the date of the ceremony.

Gifts to UK charities are also tax-free.

6. Use your capital gains tax allowance

Each of us has a yearly capital gains tax (CGT) allowance (£10,600 in 2011/2012), so only gains above this band will be liable to CGT.

In other words, each of us can make profits of £10,600 each tax year from selling assets or investments before we have to pay tax.

Any profits made above this level will be subject to tax at 18%, or 28% if you’re a higher-rate taxpayer.

So each year, before the tax year ends (now is the perfect time), consider selling assets to use up your allowance and make a tax-free profit. It’s a good idea to spread this over a couple of years to make the most of your allowance. For example, if you sold some shares today and then more on 6 April 2012, you’d be able to take advantage of two years’ CGT allowances totalling £21,200.

Don’t forget that children also have a CGT allowance of £10,600, so if they hold an investment they can make tax-free profits up to this level each tax year.

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