Tax Basics

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By Emma Tyrrell

Break out the Bolly - we're finally free. Yesterday was Tax Freedom Day, the theoretical day when we stop working for the Government and start working for ourselves - at least for this year.

Not that there's much to celebrate. Tax Freedom Day is three days later than last year, and a week later than when Labour came to power in 1997. That means more of our time is being spent filling Gordon Brown's coffers, rather than enjoying the fruits of our own labours. And it's only going to get worse: the Government's own tax forecasts show that the date when our money's our own is expected to move another week later in the year by 2009, to June 7. The tax burden hasn't been that high since the mid-eighties.

The Government is sniffy about Tax Freedom Day, which is worked out each year by economic think-tank the Adam Smith Institute. Ministers insist that the average UK family is £1,300 better off in real terms than when Labour came to power, and pout petulantly that Tax Freedom Day is not a concept they recognise.

But as we've mentioned in previous articles, the Government cunningly includes earnings growth in that figure. Strip out the pay rises which the average family could have expected in that time, and it becomes clear that the tax burden has gone up.

Tax Freedom Day shows the income tax, national insurance, council tax and indirect taxes (such as fuel duty or VAT) paid by someone on average income, as a proportion of that income. The boffins work it out by comparing government tax take with national income. They then convert that proportion into days of the year.

This year, 41 per cent of average income will go to feed the tax monster, which translates to 150 days spent working for the Government and 215 days for ourselves.

In reality of course, employees will usually have their tax bill spread evenly across the year, paying roughly the same amount each month through PAYE. The self-employed, who pay their tax either once or twice a year, will see their tax liability increasing throughout the tax year, as they earn more money.

But Tax Freedom Day is a neat way to get across the idea of how tax-hungry the Government is, which is probably why they don't like the concept.

Even though we're paying more tax on average, there's no reason to take it lying down. The organisation IFA Promotion, which exists to plug the benefits of using independent financial advisers, says nine out of ten of us are paying more tax than we should, lining the taxman's pockets with an unnecessary £5.7 billion a year. That's £133 on average for each of us. I'm not sure about you, but I think I'd like to spend that money on a couple of slap-up meals out, or splurge on a beautiful pair of impractical shoes, or even give it to charity, rather than just hand it over without protest to the Inland Revenue.

Of course a large part of IFA Promotion's agenda is to get us to take out tax-free savings products, preferably through one of its members, but it still has a good point - many of us do waste money by paying too much tax. Making sure your tax bill is as small as possible (legally!) doesn't have to be complicated either. Many of the steps you can take are pretty straightforward.

• Make sure you're on the right tax code. If your benefits package has changed at work, for example if you no longer receive taxable benefits such as free health insurance or gym membership, you could be paying too much tax. You local tax office (under Inland Revenue) in the phone book should be able to help you work out what tax code you should be on


• If you are a non-taxpayer, earning less than £4895 a year (or less than £7,090 if you're between 65 and 74, and less than £7,220 if you're over 75) make sure you're not being taxed on your savings interest. You'll need to fill in form R85 www.hmrc.gov.uk/forms/r85.pdf to give to your bank or building society, for them to be able to pay your interest gross.


• If you have children, they too can have their interest paid tax-free, as long as they are non-taxpayers (i.e. earning less than £4,895 a year). However if the money in their savings account or investments comes from you, you will be taxed on it once the interest goes over £100 a year. Money given by grandparents or other family or friends is not affected in the same way.


• If your partner is in a lower tax-bracket to you, it could be a good idea to put some of your savings and investments in their name. If you are a higher-rate taxpayer and your spouse is a non-taxpayer, this could cut the tax on those investments from 40 per cent to zero. You can shelter some of your holdings from capital gains tax in the same way.


• If you have to fill in a self-assessment tax return make sure you get it in by the January 31 deadline and pay any tax owed, or you'll be lining the Revenue's pockets with fines and interest. If you want the taxman to work your bill out for you, you'll need to get your return in earlier, by September 30. They do make mistakes though, so if you think your bill is too high, don't be afraid to challenge them


• If you have savings and investments, make sure you are using up your annual Isa allowance. You can shelter £7,000 a year from capital gains tax, and tax on interest, although the tax-breaks on share dividends have been removed. You could also choose to save into a pension, though this will lock up your cash until age 50 at the earliest (the minimum retirement age will go up to 55 from 2010). There are valuable tax-breaks available for pension savers however. They get upfront tax-relief at their highest marginal rate, meaning that a higher-rate taxpayer would pay £60 for every £100 contribution to their fund. Money within the fund can roll-up free of capital gains tax and income tax, though 75 per cent of the money will be used to provide a taxable income once you retire. From April 6, 2006 you will be able to save up to 100 per cent of your salary a year into a pension, up to £215,000. There will also be a lifetime fund limit of £1.5 million.


• If you have assets worth more than £263,000, your heirs will have to pay inheritance tax of 40 per cent on everything over that amount if you die. You can mitigate this by ensuring that any pensions and life insurance policies are written in trust (the insurer should be able to sort this out for you) and by giving money and assets to your family before you die. Any gifts made more than seven years before you die would not be counted as part of your estate for inheritance tax purposes, but you can also give away up to £3,000 a year, and up to £250 a year each to any number of recipients (as long as they aren't the same ones as got the £3,000)..


• If you give to charity you can increase the amount the charity gets by using Gift Aid, or payroll giving. If you do this the Government will boost your contribution by adding basic rate tax-relief to the gift.


• If your employer offers profit related pay, allowing you to buy company shares at a discount with your gross salary, this will reduce the amount of salary you pay tax on. If you have small children, exchanging taxable salary for tax-free nursery vouchers carries similar benefits.